Last time in this blog, we started discussing the ethics of short selling. We mentioned how it’s often the case that short sellers are looked up with something of a blend of derision and skepticism simply because their own profit is dependent upon the losses of others. However true this may or may not be, there are more pressing accusations being leveled against the short seller that demand our attention; namely, the accusation that short sellers actually harm the market.
Controversy Surrounding Short Sellers
Many of you might remember the huge stock market crash back in 1987. While there were a lot of contributing factors to that fiasco, such as the sharp increase in program trading around that time, there are many who are eager to blame the entire situation on short sellers. While there’s not a ton of evidence to support this claim, there’s enough of a correlation between spikes in short selling and downturns in the market for market regulators to have enacted certain guidelines and limitations that inhibit the short seller’s ability to actually affect the direction of the market.
Contribution To The Market
Of course, for all these claims of being bad for the market, there is one aspect of short selling that undeniably makes a contribution to the market that can’t come from anywhere else. It provides a sense of liquidity to the market, keeping trades fluid, and while it tends to drive down the price of stocks overall, it also tends to drive down those that are actually overpriced and should be driven down. In this sense, short sellers can be seen as a fail safe measure against those who would seek to commit fraud by introducing securities that they know are unstable and will soon crash on hopeful investors.
All in all, short selling is a give and take kind of situation. While many aren’t fans of it, they allow it to stick around because of the undeniable benefits that it offers the market in general. Next time, however, we’ll need to take a look at one aspect of short selling that is all-around negative: those investors who make use of distinctly unethical tactics in order to facilitate their short selling.
See you next week for part 7 of Short Selling.
Sean Rasmussen
The Bullhunters Guide
Universal Wealth Creation © 2004 – 2008
{ 4 comments… read them below or add one }
Thanks for that sean good reading.
regards Richard Colum
hi you ask me if i have read your book not yet but i bet i will find it
worth well thanks frans
Hi Sean,
This is really interesting. I guess for there to have been changes made after the stock market crash in 1987, there must have been something to the feeling that short selling was a major contributing factor.
I’m not sure I like this strategy. I don’t know if wanting the worst to happen, even if it’s only with regard to the prices of stock, is good for you.
Short selling is a fact, there are ethical and non ethical ways of doing this.
Some traders will sell their stocks if the market looks like it is going down. The market is fuelled by fear, greed and indecision.
The last market crash saw a tidal wave of people scrambling to sell their stocks to minimise their loss. Likewise there will always be short selling, it is all part of the game.