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Short selling stocks: the case for and against.

September 21st, 2008 · Greg Atkinson · No Comments

This year there has been a lot of discussion regarding the role short selling has had in causing turmoil in the stocks markets and there are now actions under way in the many of the world’s stock to curb temporarily curb this practice. But if short selling has been causing problems in the markets, why not ban it completely? Is there anything good about short selling?

Of course our views about short selling will most likely be shaped by our experiences or interests. For example stock exchanges like short selling because it increases volume and more volume means more money for them. (remember stock exchanges are money making machines, not benevolent organisations that put your interests first!)

Then there are shareholders who have seen their company’s stock savaged by short selling and investors who have had to face margin calls who probably think short selling is basically evil!

The truth is that short selling can actually be useful but as we have seen recently, it can cause damage to the markets and result in a lot of pain for investors. It is not an unethical practice in itself, but there is a temptation to manipulate stock prices and this can lead to unethical (and illegal) behaviour.

So without getting to complicated, let’s look at some of the cases for an against short selling.

The case for short selling

  • It increases liquidity in the markets.
  • It only punishes stocks that have an underlying weakness.
  • It can assist the market be more efficient by cutting down the prices of stocks that appear over valued.
  • It can help investors make money even in a bear market.

The case against short selling.

  • It can cause turmoil in the market. (as recent events have shown)
  • It causes investors pain and can damage even good quality companies.
  • It encourages unethical behaviour, such as spreading false rumours to drive down stock prices.
  • It is just a tool for greedy hedge funds to gouge money out of the market.

My view is that short selling itself is not the main problem, but rather it has been the regulation of short selling that has been found to be flawed and I would hope that recent events will lead to authorities taking a good hard look at short selling.

Yes some companies have been hit hard by short selling (and I own stock in a few) but let’s not forget that often these companies were their own worst enemies in terms of how they communicated to the market and revised forecasts etc.

In any case, I am sure we have not heard the last about short selling and it will be interesting to see what impact the restrictions will have on the market over the next weeks.

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