Hey everyone, Ross Cameron here! In today’s blog, I’m pulling back the curtain on the world of naked short selling—a shady and illegal practice plaguing our financial markets. This controversial issue has reared its ugly head with companies like AMC, GameStop, and Bed Bath & Beyond. But it’s not just about stock tickers; it’s about the very real impact on the companies, their employees, shareholders, and even retail traders like you and me. We aim for modest profits through day trading, but it often feels like we’re fighting an uneven battle against hedge funds and investment banks that play by different rules. Sounds familiar? It should, because we’ve seen this movie before—think of the 2007-2008 financial crisis.

Understanding Short Selling

To grasp naked short selling, let’s clear up what regular short selling entails. Short selling helps traders profit from a stock’s decline. You create a negative position in your account—say negative 1,000 shares. You borrow these shares from a broker, sell them, and hope the price drops. If the stock falls from $20 to $2, you make $18 per share. However, if the stock shoots up, your losses can be infinite. For example, if it rises to $500, you’re down $480 per share. See the risk?

Traditionally, for short selling, you borrow shares from someone who owns them. If a stock is easy to borrow, like GameStop often is, brokers will find shares for you to short. If it’s hard to borrow, brokers may charge you a fee to locate shares. You can even disable lending your shares to prevent them from being used for short selling. But this only scratches the surface.

Naked Short Selling: Illegal and Unrelenting

Naked short selling occurs when shares are sold short without borrowing them first. Essentially, shares are sold that don’t exist. This shouldn’t happen, but due to loopholes in digital trading systems, it does. For instance, in 2016, Goldman Sachs paid $15 million to settle allegations of using an auto-locating system to facilitate naked short selling. This practice allows traders to hammer a stock’s price down relentlessly, creating artificial selling pressure that no amount of buying can counteract.

A former Morgan Stanley employee once admitted to naked short selling daily, driven by commission incentives while the bank turned a blind eye. This type of unchecked behavior reveals a grim side of day trading that institutions exploit, leaving retail traders at a huge disadvantage.

The GameStop Saga: A Retail Revolt

GameStop’s story in 2021 is the epitome of retail trader resilience. The stock soared from $3 to $500, powered by an army of small investors who saw it as a chance to strike back at Wall Street. Hedge funds that heavily shorted the stock faced massive losses. On January 28, 2021, collateral requirements totaling $9.7 billion were waived to prevent systemic risk. Retail brokers like Robinhood even restricted buying, leaving many to wonder if these moves were to protect institutional interests over individual traders.

Impact and Future Prospects

Naked short selling not only destabilizes the stock of targeted companies but can also create systemic risk. For retail traders, it means battling against unseen forces that can tank a company’s value. GameStop’s recent share offerings—120 million shares on the open market—have diluted its value, hammering retail investors who bought in at higher prices.

Roaring Kitty, a notable GameStop champion, may have seen his gains dwindle due to these market changes. Despite his bullish stance, the dilution has hurt many retail traders. As for GameStop’s future, its hefty cash reserve of $4-5 billion positions it for strategic acquisitions. Some speculate it could become a modern-day Berkshire Hathaway of gaming, but risks remain.

The Emotional Toll of Day Trading

Trading with personal funds adds an emotional layer that institutions don’t face. When it’s your money on the line, every loss and gain feels personal. For me, it was my father’s inheritance that got me started, making every trade deeply emotional. Over the years, I’ve learned to manage these emotions through meditation, setting strict loss limits, and understanding my triggers. Discipline and a clear strategy are key. Without these, you’re just gambling and, with the deck stacked against retail traders, it’s a tough game.

Final Thoughts

Day trading isn’t just risky; it’s a high-stakes endeavor that often feels rigged against the small guy. We need to recognize the systemic issues and continue calling for fairness. Whether you’re new to day trading or a seasoned trader, staying informed and disciplined can help you navigate these turbulent waters.

Thank you for sticking with me through this in-depth look at naked short selling. Remember to manage your risk, stay disciplined, and keep learning. If you’ve found this valuable, check out my YouTube channel for more great content. Let’s keep fighting for a fair playing field. Happy trading, and see you next time!

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Warrior Trading was founded by Ross Cameron in 2012, and is now a thriving community of thousands of traders. You can learn more about joining the Warrior Trading community here.

Day Trader’s Often Ignore This One Topic At Their Peril

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Disclaimer: The results shared are based on my personal trading experiences and are not typical. Trading involves significant risk, and past performance is not indicative of future results. Always practice in a simulator before trading with real money.