Where does income from shorting stocks that crash come from?

people make money when they short a stock or mutual fund or anything of value when it goes down. where does the income come from? it's counterintuitive to me.

It comes from those who were long the stock. To simplify things, lets say that you sell short, and buy back from the same person. You short $100 shares @ $10/share. You get $1,000 from that person. You buy back those same shares at $5. You only pay that person $500. So you got $1,000, and had to pay out $500...earning you a $500 profit. The other side of the trade paid out $1,000 and only got back $500...losing $500.

Lets say you have a company with 1,000 shares, and nobody short. Now lets divide it down into two shareholders, one with 900 shares (Owner A), and one with 100 shares (Owner B). A short seller comes and borrows the 100 shares from Owner B and sells it to Owner C. Owner B, even though he loaned out his stock, has the right to recall it and sell it at any time. Owner C also has the right to sell it, so if you add up Owner A, B, and C's position, there is now effectively 1,100 shares outstanding, offset by 100 shares short. There is still 100 shares net outstanding for Owner B's position...+100 for Owner B + 100 for Owner C - 100 shares short. Before the short came along, if the stock price fell $5, the longs would collectively lose $5,000. After the short, the longs effectively lose $5,500 and the shorts gain $500. Note that the net number of shares and the net gain remain the same. Shorting creates additional shares, and the gains and losses of the additional long holders are what offset the losses and gains that the shorts obtain.

Another thing that might help is to realize that someone closing a short position doesn't get cash, they are paying out cash. They got their proceeds from selling the stock at the start. In return, they have a liability for buying it back. The "profit" is really a reduced amount of the liability. Taking our example above, when you sell short the stock at $10, you get $1,000, but you also now have an obligation to replace stock worth $1,000. When the stock drops to $5, your obligation is now only $500. However, whoever bought the stock from you paid $1,000, and now has an asset worth only $500. Overkill on the answer in all likelihood, but hope it helps.

They sell the stock(short), then they buy it back for a profit. They never owned it, they borrowed someone elses shares to sell. The profit is the difference from what they paid for it to what they sold it for.