I generally try to avoid stereotyping people with generalizations. Still, I'm pretty much at my boiling point on this one. I have come to the realization that I can't stand people who regularly short stocks.
What Is Short Selling?
Shorting a stock is basically the opposite of purchasing a stock. You short if you believe that a stock is going to go down. You basically ‘sell' a stock at the price it is today, and then later on close the position by ‘buying' it at what the price is at that point. So, if a stock falls 10%, you basically make that money as profit.
There's risk. If the stock goes up, the short seller will lose money. And since a stock can go up forever, the risk is unlimited.
Why Do I Dislike Short Sellers?
I do a little trading in stocks now and then. As such, I follow the stocks in which I have positions or am interested in potentially opening a position. I follow message boards and forums. It's what I've seen here that really shapes my viewpoint.
Disclaimer: I want to make a distinction here. Although I've never shorted a stock, I have thought about it in instances. For example, sometimes I believe that I think a stock is overpriced. So the occasional short seller is not my nemesis.
- They are the meanest people on message boards – Message boards aren't my primary means of getting information, but they help. They provide information on overall sentiment. I've always found that short sellers are mean and negative. I guess they have to be given their objective.
- Short selling is, by itself, negative – Movies and books finish off with a happy ending most of the time. It's what people like. Short selling is akin to an unhappy ending in a movie. A person shorting a stock is hoping that it goes down. It's just all too negative for my tastes.
- The perception of corruptness – If you open a trading account and want to short a stock, your broker is supposed to have the corresponding shares available that you're shorting, generally in the portfolio of another investor. After all, you can't simply create shares out of thin air. This would be ‘naked short selling' and while this is illegal, you'll find that there are few out there that don't believe it doesn't happen. And, we're not talking retail investors, we're talking that there are hedge funds out there opening short positions that they can't cover, but because the SEC effectively enforces nothing, who's to stop them? Nobody.
Regulation Is Needed In The Practice Of Short Selling
I think that three things need to happen to control the short selling that I believe has gotten out of control.
- Monitor naked short selling – Spot checking should be done to match up short positions with available shares to ‘buy'. If they don't match, then there is naked short selling occurring and this should be punished.
- Identify and punish short manipulation – It's generally believed that hedge funds that have large short positions will often open and close small positions to drive down the price. This works in periods of low volume. In a simple example, if you've got three investors each with 100,000 shares short, and there is no volume, then they could start trading 100 share blocks between themselves, pushing the stock down with each trade. What reason would someone holding 100,000 shares short have to buy and sell 100 share lots in a low volume day?
- Re-implement the uptick rule – For awhile, there was a rule that a short trade could not be executed until the stock went up. If a stock was trading and went from $10.00 -> $9.95 -> $9.90 -> $9.85, then a short transaction would not be filled. Only when it went back up to $9.86 would it be filled. This was designed to prevent shorts from accelerating a declining priced stock. But, that rule was ‘suspended' and now it's easy to jump in and short a stock that is already lowering in price. This has the snowball effect of pushing the price further down, not to mention that it keeps potential buyers on the sideline who know that it's being attacked, which ends up hurting the price even more!
As you can tell, I have no love for those who short stocks. I don't believe that the market always needs to go up, because that's unreasonable and that's how bubbles happen. But, I equate shorts with vultures, in that they're simply opportunistic and greedy and take a bad situation and make it worse. Why in the world do we advocate that?
Readers, do you have any knowledge or opinion on short selling stocks? What do you think?