If people have to have their own funds to short sell, then why do they borrow from someone elses portfolio if?

Question

they can afford their own? this makes no sence?

Answer 1

The reason is that if a person sells something he owns he does not profit from a decline in the price.

Let's say XYZ is selling for $50 per share and I think the price is going to go down. If I buy the stock for $50 and then sell it, I have no stake in what happens when the price changes in the future. It would have no impact on the value of my account.

However, if I sell it short for $50 and the price goes down to $30, I will have made $20 per share if I cover my short position at that price.

Answer 2

They have to have funds located and secured by a brokerage for borrowing.  The reason is that, opposite of a normal buy/sell transaction, short sales are a sell first (the borrowed stock) then buy second transaction, at which time the stock is then "returned" to the original owner.

Remember, the normal transaction is one of expecting the value of a stock to go up, so therefore the investor has a goal of "buy low, sell high" and pocket the profits.

The short sale transaction's goal is the inverse of the above, when the investor or trader (there are long period and short period short sales) expects the stock value to drop, therefore it is first, borrow the stock, then "sell high, buy back low", pocket the difference, and finally return the borrowed stock to owner.  

The reason the person can't "buy" it first, is because they don't believe it is going up, so they don't want to OWN it, they only want to borrow it so they can profit on its anticipated drop in value.  This helps create a market.  If everyone believes a stock is going up, and everyone who wants some has already bought it, the price will stagnate and not move.  By having shortsellers in the market, a more healthy market is created, and companies and their officers are "made more honest" by having to do the right things to grow the value of their companies.  Otherwise, the market's most intelligent observers will move in and hold them accountable.  This is why large investors who are highly liquid - Buffett, Icahn, Pickens and others, move in an buy companies which are inefficient, and either split them up for resale, or put new leadership in play to improve the stock.  We need all sides of a trade to be represented to create a market.

A closely related strategy to both positions is when someone buys a stock, but buys "put" options for the future that go up in value if the stock goes down.  In this manner the investor can participate in a position, without being at risk of a total loss in the event the market takes a plunge.  Should their stock do fabulously well on the upside, the only loss they will take is the cost of the puts. And they will be happy to pay it for the potential of "putting off" loss if their stock had instead gone down.

Likewise, if one expects a stock to improve in the future, one can buy a "call" which means you will "call" in the right to sell the option at a profit, over its purchase day valuation, should it go up in its potential value.

I hope this helps you.