All right everyone. So here we go. We're gonna get started here. and the topic of today's episode is Naked Short Selling uh Traders Over the last few weeks have been asking me about this.

uh, quite a bit. It's something we've talked about extensively. Uh, certainly during the Game Stop short squeeze, the topic of Nate make a short selling was um, it was very popular. A lot of people were had, you know, various opinions on it.

So I thought for this episode what I could do is I could talk about uh, what naked Short Selling is, compare it and contrast it against traditional regular Short Selling and um, we can. uh I Think we can also get into a little bit of breaking down. Uh, one of probably the biggest examples of a short squeeze. So the topics for today's class: Naked Short Selling versus regular short Selling the prevalence of Naked Short Selling and the impact of Naked Short Selling in the market today.

Plus, anytime, uh, during this Workshop there'll be a link right down down the description those they're watching on. YouTube You could download five free resources that includes a PDF outline my small account strategy, a PDF outline of my micro pullback strategy, the PDF of my pre-trading checklist, and a live trading archive showing order execution, and a special video on the topic of holding losers too long which is something that many Traders struggle with uh, you might you're not alone and I struggle with it, even myself. Alright, so let's get right into it with Naked Short Selling versus regular Short Selling So short selling is the practice of selling a stock with the intention of buying back those shares at a lower price and profiting from the decline in the stock. Now that's in a perfect world.

The reality is a short can go wrong just like uh. Buy long-sided trade can go wrong. so if you short a stock and it goes higher, you have to buy it back at a higher price, which would create a loss. Short Selling Emerged in 1609 with shorting of the Dutch East India Company In the Dutch Republic Following a stock market crash in 1610, it was temporarily banned.

Now that's just shorting regular shorting. Not even, um, naked shorting. Many of you have heard of the short sale restrictions, so in 1938 in the U.S the short sale restriction SSR was created all right. It was called the uptick rule because it only allows short sellers to sell short against the ask price when the stock was moving up.

So I'll show you um, what that looks like. So this is fairly straightforward, but for those that maybe aren't familiar. so you have a stock here, you've got the bid price and then you've got the ask price. So let's say you've got 310 on the bid and 315 on the ask.

What? You weren't what you're not able to do when a stock has short sale restriction is short. At the bid price, you can place an order to short at 3 15 or you could put an order between the spread. You can cut the spread and put it at 314, but you can only short on an uptick right here. So that means you're putting your sell order on the Ask and your order is only going to get filled when someone is pressing the buy button and they're going to buy your shares at 314..

So what this prevents is a bear rate. A bear raid is when short sellers Hammer the bid on a stock to drive the stock lower, thus forcing Panic selling among long Biased Traders And investors Now bear raids can still happen today, but as soon as a stock goes down at least 10 percent, the short sale restriction will be turned on and they can only short against the ask. So in 2010, the uptick rule was revised to only take effect when the stock drops at least 10 percent in one day. Previously, it was, uh, that's not how it was, it was just that's that was the SSR.

But now it's only when a stock drops 10 in one day. So as you probably can imagine on a small cap stock that's priced at three dollars, dropping 10 in one day isn't very difficult. So it's very common that we will see stocks with short sale restriction. Uh, but that doesn't stop.

Short Selling But it does prevent shorts from, you know, conducting these bear raids where they just Hammer the bid and cause these flushes in stock price. Now in naked short is different. A naked short is when the shares are so short in the market without actually borrowing them from a seller first or from someone who's holding them. So due to the digital nature of the markets, it's actually kind of crazy.

It's it's easy with the click of a button to assign a block of shares to an account, even if those shares don't actually exist. Now that practice is illegal in the United States but it continues to occur on a daily basis and this is. this is an area where obviously, um, you know there's there's controversy and uh, we'll We could talk a little bit about that, but it's certainly a problem. and so let's let's just get into short interest for a second.

So um, a record is maintained for all stocks to report on the number of shares that are held short against the company. So if a stock has a float of 10 million shares and 1 million Shares are Borrowed by the short Sellers and are short against the stock, this creates a short interest of 10. All right. So at its peak, GameStop had a short interest of 141 percent.

How does that happen? That should not be possible. It shouldn't be possible for short interest to ever exceed 100 and and realistically even to get to a hundred percent is is Unthinkable because it means every share held is actually short the stock, it's it's it's quite. It's quite remarkable that this could happen. And so if we look, um, sort of at a whiteboard, one of the things that, uh, that does happen uh, currently is that so somebody buys they buy the stock here all right now.

they may not realize it. but if you own a stock and you own it with, you know whatever broker you have. Unless you've told the broker not to lend out your your stock, what they can do is they can actually lend out your stock to someone here who's saying hey, I want to borrow some shares to short it and so they'll lend out your shares right here to this person who shorts it. So this person goes and they press the sell button in the market.

But what happens? Well when they sell someone else presses the buy button and then that person's holding the shares and then we go around again and that person's broker someone says hey, I'd like to borrow some shares and they press sell and again someone else buys. And so this actually can create a loop where the same share here is actually been shorted multiple times. And so it's not just the um, the practice of naked short selling that creates this exponentially uh, High short interest. It was also this process of lending out shares to borrow.

Uh, so so that's just a very, very brief and we're gonna, just you know, get right to the point here in this episode. So thank you guys as always who are tuning in and thank you for those who have hit the thumbs up already. Uh, so let's talk about the prevalence of Naked Short Selling So um, does it really still happen today and this is um, uh, this is a a veteran Wall Street Banker Who says and this is a quote He said I would illegally short naked short stocks every day every day. As long as I was collecting commissions and the bank didn't care, a client would send you an order electronically.

All you do is click the order you go to execute. It'll pull up a little box, you type anything you want and you hit OK. You don't ask questions, you appreciate the order, and if that involves shorting a stock naked, you do it anyways because management essentially tells you, just create the business and he continues to say clients never see that. all the prime lenders, they all do it consistently.

So this is uh from the HBO documentary which some of you may have seen called Gaming Wall Street So this is the fellow here talking about this. As long as I was collecting commissions and the bank did not care, the claim will send you an order electronically. All you do is you click on the order you go to execute. It'll pull up a little box, you type in anything you want, and you just hit.

Okay, that's it. Last questions: appreciate the order and if that involves shorting, it's not naked. you do it anyway. You do it anyway.

So you know this is. um, so the question is, what's the prevalence of this in the market today and it certainly sounds from this fella who's a veteran Banker has been doing it for forever that it happens every day. I Would illegally naked short sell stocks every day? If you guys haven't checked out that HBO Documentary Gaming Wall Street You should check it out. It's interesting.

So uh, Goldman Sachs paid a 15 million dollar um settlement to settle allegations made by the SEC about an F3 button used to Auto locate shares. So there's um, the the Pr related to that. So what they, um, what they essentially did was each day at the beginning of the trading day, there'd be a set number of shares that were available to trade Midway through the day that, uh, that inventory of shares available would dry up, right? it would. It would run out.

People would borrow the shares, but you would have people calling saying Hey I Want to borrow shares I Want to borrow shares And so they thought their Auto locate Um system. Their computer system was maybe too conservative and that there actually were probably some more shares that they could that they could find somewhere. And so they created a button. uh, under the reasonable belief that they would find shares.

And when they pressed that F3 button, it would override the number of shares that their own system had told them was in inventory and it would just grant the shares available to borrow just with one press of the button. So now if you think about this, you, you shouldn't be able to just create shares out of nowhere. Right when a company does its IPO right? So the IPO they sell shares. Let's say they sell 10 million shares onto the market.

From that point forward, there are 10 million shares available to trade. There are people who have bought all 10 million because that's how the IPO works. So they bought 10 million. These are owned by individual people and institutions.

Banks Etc Now those people with their Brokers they can lend out the shares and they can let someone else sell those shares into the market, right? But it is a closed pool. This is how many shares are available to trade. And so if your wine is short a stock, you should always be shorting with the knowledge that you're borrowing from somebody. So there's this um, you know, kind of uh, I don't know what you'd call it just a an example of Short Selling So so let's say just for example, that um, that I see somebody? um uh, I see somebody out there on on Craigslist or Facebook Marketplace Who says I want to buy a lawnmower right here? so I want to buy a lawn mower? I'm going to draw a picture of a lawnmower.

Okay, by the way, uh I am an artist so this is a lawnmower. they say I want to buy this for 300 bucks I'm looking for a lawnmower working good order. 300 bucks all right now I happen to know that my neighbor right now is on vacation I Also know he's got a pretty decent lawnmower. All right.

So I go and I grab the neighbor's lawnmower now that's a real physical product I grab the neighbor's lawnmower I sell it to this guy for 300 bucks and then I go over to Home Depot and I use a coupon code or something like that and I buy back the same lawnmower for 200 bucks I put the lawnmower back in my neighbor's garage. He's none the wiser because he's not that smart anyways. and I get to pocket a hundred dollars. That's a short essentially, but it's based on a real product right here.

Now you can't Just, you know, create more share. You can't In the lawnmower. instance, you can't just like with a press of a button, just create more lawn mowers and just keep selling them for 300 bucks for 300 bucks for 300 bucks for 300 bucks. And yet with this F3 button, what could essentially happen is you just keep creating more shares.

You create more shares, More shares. more shares, And you press sell button, You press sell button, You press sell button, you press sell button and that act that's obviously going to create an unnatural level of cell pressure. So in the movie Um or the Documentary Gaming Wall Street they have this clip where they talk about 32 enforcement actions and these 32 enforcement actions were against Um different big institutions for abusive and illegal Naked. Short Selling They total 64 million dollars in fines.

The Goldman Sachs one for 15 is like right here: 64 million dollars in fines. And listen, these are companies that have profits that are billions, billions of dollars. So when that Wall Street veteran said the the the firm essentially tells you, Management tells you, just generate the business, just get the business. We'll figure it out on the back end.

It's because they know that at the end of the day you know a 15 million dollars of penalties is is nothing. It's it's just the cost of doing business. It's like getting a a traffic ticket. So how to prevent Naked Short Selling Well uh, regulation Sho and I Always say rag show Um Reg Show is a set of rules designed to regulate Short Selling and prevent Naked Short Selling So a stock will be placed on the Reg Show list if for five consecutive days it has a failure to deliver that exceeds 10 000 shares.

So a failure to deliver means essentially for every trade you take, that trade has to settle. There had to be a buyer to match the cell. There has to be a seller to match the buy. So every trade has to clear.

It's like clearing a check. And so if you're having failure to deliver, then that that is a indicator of Possible Naked Short Selling Which at small, small percentages of one or two percent or whatever of all, the volume could just be negligible. And it's just part of you know these things happen. It's the system.

It's nothing's perfect. But when it happens at large, um, consistently, and uh, to look at in large amounts, that's when an indicator of something more significant happening. So this list includes or so. The regulation includes a closeout requirement.

meaning if a transaction fails to deliver uh, that that transaction has to be that short seller, their position has to be covered immediately. It has to be closed out. That position has to be closed out due to the clearing from not being able to provide the actual shares required to clear the trade, right? Okay, so stocks on the Reg Show list are looked at as targets for potential or possible short squeezes, because if a stock is repeatedly on this list, it could indicate to Traders Institutional Traders or retail traders that maybe there's some Naked Short Selling going on. So on.

GameStop The data showed 350 million dollars of shares failed to deliver. All right, so that that is a significant number of shares. Okay, so so we know. Now the question: What is the prevalence of Naked Short Selling And it's very prevalent, at least according to one, uh, industry veteran.

Uh, now you've got What is the impact of Naked Short Selling Is there any impact at all? Does this even make a difference? Is Naked Short Selling even bad? So if you request to borrow shares and you can sell an unlimited number of shares due to the prime, Brokers allowing Naked Short Selling by pressing, you know well the F3 buttons been eliminated now. but you know in theory if they've come up with some other mechanism to achieve something similar. what you could do is you could flood the market with an imbalance of orders to the sell side. This would drive down the price of a stock.

Imagine being able to constantly put up a wall of 500 000 shares on the ask and anytime some people tried to buy from you, you could just reload with another 100 000 shares and then every 15 20 minutes you just drop the price of your order down by 25 cents. You just keep dropping it down and dropping it down and dropping it down and dropping it down. That is unfair. and of course it's illegal, but it's been used by Traders to essentially Force stocks into de-listing and even into bankruptcy because it can drive down the price of the stock.

It can bully out any of the long biased traders who eventually capitulate. They have to give up and then you of course have those sellers hitting the bid as well. So what GameStop did was it put a spotlight on this practice. and since GameStop it's been a topic of discussion.

Any any time you see a stock that's their price is just getting hammered. They're plummeting. They're just unrelenting selling. They accuse, uh, naked short sellers of orchestrating this.

Um, you know this bear rate on their stock and they say that they're hiring former FBI investigators to get to the bottom of this and we don't know? You know. The thing is, the market and the plumbing of the market is incredibly complex. We don't know with certainty exactly what's happening, but of course, the stock prices speak for themselves. and so the GameStop short interest hit 141, right? So by allowing a share to be lent out multiple times, and by allowing Market participants to sell short in excess of the float which shouldn't be possible, short sellers were able to drive the stock to record lows before the squeeze.

What the big hedge funds didn't expect was an army of retail Traders on social media banding together to stick it to the mail with regular Americans opening up their Robinhood app or their retail you know, trading accounts and pressing the buy button. Suddenly volume surged over 150 million shares a day as Gamestop went from 19 to over 500 a share. buying shares in GameStop became a political statement. A chance for the little guy the underdog to Stick it to the Man and get in one good punch.

These were the memes: my mom after watching the news. have you heard of the Reds or the Reddit movement me holding one chair I am the movement? Take your game. Sell it, Sell it Never. You could take my arms but you can never take my shares.

This was the theme. this is what was happening it was on. Reddit The Wall Street bets Forum went from having a couple hundred thousand subscribers to having millions of subscribers I mean anyone that I was seeing all over social media people that you know in wall in uh in um elevators would say oh hey, have you heard about GameStop Are you oh yeah I'm in GameStop I'm holding 11 shares. Everyone wanted a piece of this action and the institutional Traders and the hedge funds they didn't see it come GameStop sitting amongst Tesla and Amazon after Reddit users make it a Fortune 500 company dare to use my own spells against me Potter You know So this was uh I mean this is the this is an open market and you had a massive imbalance to the buy side.

So what it created was widespread Market Risk the GameStop short squeeze placed short Sellers and the prime brokers who allowed Naked Short Selling but even just regular Short Selling with unrealized losses in excess of billions of dollars, So Dtcc, which is used for clearing trades, reportedly waived 9.7 billion dollars of collateral deposit requirements on January 28, 2021 by waiving the collateral. Deposit They prevented the widespread systemic risk to the entire Financial system that would have resulted from large institutional Brokers defaulting on their obligations. Short sellers became too big to fail and they got a bailout. So at the peak of the squeeze, many Brokers including Robin Hood removed the buy button and they said they did it because if people kept buying, they wouldn't be able to meet the collateral obligation and they would default.

But what is removing the buy button do? Removing the buy button, removing all the buy orders from the equation let the short sellers regain control. and on that day, the stock price fell by over 75 percent. That's incredible. That's really, really wild now What? Amplified and already incredibly volatile situation was options trading.

Citadel is the largest option to Market maker in the world. So large firms like Citadel use algorithms to maintain prices on options and to manage their own risk. So if they sell an option, call contract as the seller. They're obligated to buy shares if the option is exercised right.

So they're essentially putting themselves in this position where someone else wants to buy the shares and they have to sell them the shares. So if they so they have to sell the shares, so if they don't already own the shares, then they have to buy them. Now if you already own the shares, it's a covered call and that's that's a relatively safe options trade. You get the you collect the premium from selling the call and then you have to give up the shares that you own if that option contract is exercised.

But if you have the highest level of um of options writing, you can write naked calls and puts and when you do that it's similar to shorting a stock. You accept it with options. For every one contract that's sold naked, you're on the hook to buy a hundred shares. GameStop had options.

Volume that peaked at 2.4 billion dollars on January 27th 2.4 billion dollars of options volume. So imagine being short a hundred thousand calls as Gamestop goes up 400 points in a matter of days be equivalent of being short 10 million ships. We're talking about billions of dollars at stake, billions of dollars in unrealized losses when Gamestop hit its peak. So what would have happened if the buy button didn't disappear or what would happen if Dtcc hadn't waived the 9.7 billion in collateral obligations? What would have happened if GameStop went to a thousand bucks many of you saw HKD earlier this year HKD was a Chinese IPO that went from about 10 15 a share to a high of 2 500 a share Now it didn't have the volume, It didn't have the options volume.

It didn't have all of the things that allowed that stock to potentially break the entire Financial system. But GameStop Wow, that was different. Naked Short Selling allows the price of a stock to become incredibly disconnected from the true market value of the company. Because let's not, let's not mistake ourselves.

GameStop In a matter of a week, became a Fortune 500 company. But what in their business model actually changed? What in the company's actual profit change? Really, it was not much they brought on. Um, Ryan Cohen I Think his name was, is that was that his name? Uh, from Chewy.com right? So I mean there were things that happened. But but let's be realistic, the price became incredibly disconnected from the true value of the company.

and it probably did make sense when it was up around four or five hundred dollars a share. To that, it was a good short for a reversion. Back to it's probably more correct valuation, but both options trading naked options, writing and naked Short Selling and just standard Short Selling created an environment where all of a sudden you had very low liquidity as the stock exploded. This is sort of.

One of the things that's really interesting is that there's the argument that high frequency trading algorithms improve liquidity in the market because a high frequency trading algorithm is always and a market maker is always on the bid, they're always on the apps. so they're creating a lot of liquidity. You want to get in. Boom! There's someone there to buy your shares, Your Ursa sell you shares.

You want to get out. Boom. There's someone there to buy your shares. So they're sitting there and essentially what they're doing.

it's Arbitrage because they're just waiting for someone else to come and buy the shares that you just sold them. So they're just flipping shares all day long, all day long, all day long. At the end of the day. if they've bought and sold roughly equal number of shares, they profit from the spread and they've made money.

But when the stock starts experiencing high levels of volatility, all of a sudden those orders they thin out because the the market makers they can't just leave in order to sell a million shares on the ask because what would happen is they would become imbalanced in their portfolio by just selling. selling selling selling. So their orders respond to demand and these are very complex systems. They respond in real time to demand.

but when you have these spikes in demand or these surgeons Supply where lots of people are selling, then all of a sudden the orders that create all that liquidity start to get pulled back and away from the market. And now what happens is you have these stocks where that you get really big moves on actually very light liquidity, light volume. And the problem there is because there's not a lot of liquidity if you were in a 500 000 share short position. Getting in and out wasn't too hard when there was a lot of liquidity when it was range bound.

But now as it's ripping, it's really hard to get in and out. And you will actually fuel that short squeeze by having to buy back 500 000 shares at market prices while it's going up. which you would have no choice to do because you were at an unrealized loss that's getting bigger and bigger. And bigger and bigger.

Now of course, you could use options to hedge your trade, your position, but ultimately, there's only so much you can do. and when there's not enough liquidity, you're going to have a hard time unwinding that position. So how do you know if you're a short seller, whether the shares you've been, uh, shorting have truly been found, or if your broker has, even without them possibly knowing it allowed naked short sale? Because as this fella said, the Wall Street veteran, uh, clients don't know, they don't even know. And is it possible that the GameStop short squeeze could have brought the financial Market the financial system to its knees.

and I think the answer to this is it very nearly did I mean it. It wiped out several big hedge funds. There was a hedge fund Melvin Capital had 12 billion dollars at the beginning of the year. that hedge fund is gone.

they've closed. They lost I think over six billion dollars in the month of January 6 billion dollars. This is crazy and it really is. I mean the combination of the the naked Short Selling Which allows these Wall Street Firms just print money, but also this ability to bully these stocks into Oblivion where they just are bullied.

Bully bully bullied until they're just gone. They have to de-list they're out of business. It feels it feels Un-American It feels like it's not. um, it's not fair and it shouldn't be allowed to happen.

And there's a lot of big firms that profit tremendously on the failure of uh, these stocks and them going out of business. and they have a real vested interest in watching those companies fail. So if you found this episode on Short Selling Interesting. I Hope you hit the thumbs up.

and I want to remind you that you don't have to do this alone every single day. I'm live streaming while I'm trading of course I did trade GameStop It was one of the uh, it was actually the best week of my career on that week. I made just under a million dollars trading. It was insane now.

I say that not to brag, but I say that because it's real and I think it's valuable that you know the person you're learning from is qualified and is actually profitable. And I certainly am. Uh, so that was a big week that was pretty crazy and I would love to give you guys a chance to continue to trade uh side by side with me if you'd like to. So make sure you check out some of the free resources in the link down below and these are the patterns: I'm trading pretty much every single day I Want to remind you as always, my results are not typical.

There's no guarantee you'll find success when they trade with me or you'll learn on your own. So always take it slow and practice this simulated before you put real money on the line. But I hope you found this interesting. If you are interested in learning more about the market, you've certainly come to the right place.

You're on the journey. So thank you guys! Um, before tuning in today and I'll see you back at it uh, next week for another special episode that I'll stream uh right here Live on YouTube probably Monday at around 11 A.M So I'll see you guys then. Thanks as always for tuning in and I hope you guys have a great rest of the day.