Why is short selling bad, either naked or smartly dressed?

IronWing

No Lifer
Jul 20, 2001
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Politicians, CEOs, and others trying to hide their own culpability in the current mess have decided that it is really the short sellers that are to blame. So, what's wrong with short selling?
 

dmcowen674

No Lifer
Oct 13, 1999
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www.alienbabeltech.com
Originally posted by: ironwing
Politicians, CEOs, and others trying to hide their own culpability in the current mess have decided that it is really the short sellers that are to blame.

So, what's wrong with short selling?
If I wished you dead would you not consider that a bad thing?

What makes short selling any different?
 

Vic

Elite Member
Jun 12, 2001
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Nothing wrong with short selling except when the hedge funds gang up to cannibalize every banking/financial stock.
 

Mani

Diamond Member
Aug 9, 2001
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It's not in and of itself bad. Nothing illegal, or even frankly unethical about it. Short sellers are just easy targets.
 

Vic

Elite Member
Jun 12, 2001
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Originally posted by: dmcowen674
Originally posted by: ironwing
Politicians, CEOs, and others trying to hide their own culpability in the current mess have decided that it is really the short sellers that are to blame.

So, what's wrong with short selling?
If I wished you dead would you not consider that a bad thing?

What makes short selling any different?
Your logical mistake here, Dave, is that wishing thinking by itself doesn't make anything happen.

It's just like gambling. You can bet the shooter to win or you can bet him to lose.

edit: fixed typo
 

Engineer

Elite Member
Oct 9, 1999
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How about naked shorting? The ability to basically create as much stock as you want (nothing to back it up by borrowing) and sell it.
 

IronWing

No Lifer
Jul 20, 2001
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Originally posted by: Engineer
How about naked shorting? The ability to basically create as much stock as you want (nothing to back it up by borrowing) and sell it.
I don't see the difference between this and selling other types of futures contracts. Eventually, the seller is going to have to come up with the stock.
 
Oct 30, 2004
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Is this the same as a "Put" option? Short-selling isn't guaranteed to bring in a profit, is it? What happens if the value of the stock increases?
 

Kuragami

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Jun 20, 2008
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Individuals short selling is not the issue. The companies that typically get ganged up on by individuals are the ones that are visibly about the go kaput. Hey if your business blows don't expect mercy in the marketplace. That's what a free market economy is supposed to be. It's not all peaches and cream. And they should be punished for poor business practices.

As mentioned before it's massive institutions, the very same ones who went crying to grandpa Fed about being shorted, are the ones typically responsible for the same thing with one huge difference. They are so big that they can virtually crush a stock on the market. This was made far easier once certain rules were lifted that previously required traders that shorted stocks to only do so if the stock had upward movement. This way traders couldn't all dog pile a stock and crash it within hours. The problem with this is that it was hardly enforced to begin with. It's great to have rules, especially ones that make sense, but they aren't worth a damn if you aren't enforcing them. As soon as this law was lifted it was open season to start shorting stocks. Silver is a favorite short of these massive institutions and always has been due to the metal's violent movement.
 

Dissipate

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Jan 17, 2004
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Originally posted by: WhipperSnapper

Is this the same as a "Put" option? Short-selling isn't guaranteed to bring in a profit, is it? What happens if the value of the stock increases?
Eventually you get something called a margin call.
 

Kuragami

Member
Jun 20, 2008
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In case someone gets any smart ideas.... Stay away from doing any business with Comex. They sweet talk newbies into putting their money into really dangerous stocks and they typically get burned with margin calls.

I don't know much about trading but I know enough about what not to do unless you are very experienced and shorting stocks is one of those things. Just in case someone was thinking of jumping into this. Anyway Comex is pretty bad and I keep reading about newbies getting burned for 10-20k on a single margin call.

I'm a firm believer in that certain functions of the stock market should be off limits to newbies without a test of some sorts. People think lawyers are blood suckers but they don't hold a candle to some of these trader firms. Can't even compare the two. It's like comparing Count Chocula to Vlad the Impaler.
 

Thump553

Lifer
Jun 2, 2000
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The SEC either gutted or ignored certain critical rules on shorting that have greatly worsened the current crisis on Wall Street. Two main examples: naked shorting (the ability to sell stock without possessing it) and the repeal of the uptick rule (If you do repeated short sales, the subsequent sale has to be at least one tick higher in price). The result-as clearly shown in Lehman Brothers and almost came to fruition in AIG-is that a near panic can result be manipulating prices to cause a rapid plunge-it becomes self fulfilling and the company is busted in a matter of hours or a day or two, before regulators can step in.

There is nothing wrong with shorting, per se-I've done it several times-but under the current rules, the gigantic hedge funds have used it to destablize the market and wreck companies.
 

StageLeft

No Lifer
Sep 29, 2000
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Apparently naked shortselling was already illegal as of 2005. Shortselling itself should not be. At its essence, shorting is just saying that you believe a stock will fall. It is a low level of confidence in the stock, but if I sell you stock at $50 because I don't think it's going to grow quickly, don't I already have less confidence than you do about its future? Of course, that's why I'm selling it, so in that case you may expect it to rise, but I expect it to rise less, so I sell it and let you have it. Shorting is simply not just a low level of confidence in its rise, but a low level so much that the shorter expects it to fall. It's all on the same scale, just quantifiably to a different extent.

Now, if the UK has made ALL short selling illegal for financial stocks, all that means is that if you're into stocks for growth, you avoid them, because it will stabilize them in both a positive and negative fashion, so they'll have less movement.
 

LegendKiller

Lifer
Mar 5, 2001
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Originally posted by: Kuragami
Individuals short selling is not the issue. The companies that typically get ganged up on by individuals are the ones that are visibly about the go kaput. Hey if your business blows don't expect mercy in the marketplace. That's what a free market economy is supposed to be. It's not all peaches and cream. And they should be punished for poor business practices.

As mentioned before it's massive institutions, the very same ones who went crying to grandpa Fed about being shorted, are the ones typically responsible for the same thing with one huge difference. They are so big that they can virtually crush a stock on the market. This was made far easier once certain rules were lifted that previously required traders that shorted stocks to only do so if the stock had upward movement. This way traders couldn't all dog pile a stock and crash it within hours. The problem with this is that it was hardly enforced to begin with. It's great to have rules, especially ones that make sense, but they aren't worth a damn if you aren't enforcing them. As soon as this law was lifted it was open season to start shorting stocks. Silver is a favorite short of these massive institutions and always has been due to the metal's violent movement.
A "free market" is abusive and not very healthy for anybody. Free market doesn't mean it should be allowed to slit its wrist.
 

Craig234

Lifer
May 1, 2006
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Originally posted by: Skoorb
Apparently naked shortselling was already illegal as of 2005. Shortselling itself should not be. At its essence, shorting is just saying that you believe a stock will fall. It is a low level of confidence in the stock, but if I sell you stock at $50 because I don't think it's going to grow quickly, don't I already have less confidence than you do about its future? Of course, that's why I'm selling it, so in that case you may expect it to rise, but I expect it to rise less, so I sell it and let you have it. Shorting is simply not just a low level of confidence in its rise, but a low level so much that the shorter expects it to fall. It's all on the same scale, just quantifiably to a different extent.

Now, if the UK has made ALL short selling illegal for financial stocks, all that means is that if you're into stocks for growth, you avoid them, because it will stabilize them in both a positive and negative fashion, so they'll have less movement.
I disagree with your statement in the word bolded above.

Supply and demand set the stock price when shorting is not allowed. There are so many shares, so many buyers who will pay a certain price. You think the stock will do down, you sell it or don't buy it, that has an effect to lower the price of the stock. That's a 'free market price'.

Shorting has the effect not only of you stating your opinion. It in effect increases the number of shares for sell, and that, under supply and demand, lowers the price.

That's a lowering in addition to the normal lowering when people sell their shares.

The thing is, without shorting you can't *profit* from your opinion. As you can imagine, your produt from shorting has to come from somewhere, it's not 'free money'.

And when practiced by 'predatory institutions' (if not a panicked public), it can strongly manipulate the market for a stock. Manipulating the market for the stock means they profit from the manipulation (when it works) while others lose money. It's been around as long as the market; it's one thing to pick good stocks, hold them and profit from the increase. But that's not enough for some people, who want to make a lot more money, whatever the impact on the economy.

Before the great depression, a common technique was for wealthy investors to create a manipulation by buying up a bunch of shares and spreading rumors the stock was going up. People would buy it to profit, the wealthy investor would sell the shares he previously bought at the lowe price for a profit, investors would see the increases halted and try to get out before the crash, creating the crash, and the stock would typically end up where it had been, with the rich guy who had the money to do this wealthier, others who lost.

The shadier practices in how the manipulations were done were why the SEC was founded to keep the market less 'corrupt'.

You can say what you like about shorting, but IMO it has mor effect than just you offering an opinion. It's not like some side bet not affecting the stock, it affects the stock.

As an outsider to the industry, I'm not really sure why shorting should be allowed, since its main purpose seems to be to allow traders to have new ways to profit. I'm not sure what societal benefit, what benefit to the companies or long-term shareholders, there is to shorting. They might offer some rationalizations, but net it out, what's the benefit, really? Maybe there's some benefit I' haven't heard. And I don't really hear anyone saying it should be banned, though there are restrictions on some shorting to limit abuse.

I'm not saying shorting has any apparent terrible problem in most cases, just that I'm not sure how bad the harm would be for it not to be allowed. I invite an answer to that.
 

nergee

Senior member
Jan 25, 2000
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So, they ban the short sellers and the market continues down...who are they going to blame then?
The problem is banks are insolvent, plain and simple.....
 

IronWing

No Lifer
Jul 20, 2001
64,699
19,108
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Say I own stock in a company. I'm a long term investor and I don't need to cash out anytime soon.
The stock may or may not be overvalued on a particular day but the company is basically a financially sound,
well run business.
A handful of funds short the stock on a massive scale.
The stock price plunges.
Taking my normal approach to these things, I recall that there is nothing in the news or or in the company reports suggesting that I aught to think the price should be plunging so I sit on my hands or even buy more shares.
The stock price keeps dropping.
The short sellers need to cover their positions and buy the now cheaper stock to fill their contracts.
The stock price stabilizes or starts rising.
The P/E ratio should be improved with the lower stock price.

How does any of this effect the company's ability to continue doing business in the manner it was prior to the run? The company has the same people, the same assets, the same customers, the same profits.

As a long term shareholder I expect that the stock price will eventually reflect the company's performance and come out fine.

It seems to me that the only folks who get burned are shareholders who take the bait and panic or investors who agreed to buy the future contracts (gambled and lost).
 

Mark R

Diamond Member
Oct 9, 1999
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Originally posted by: ironwing
How does any of this effect the company's ability to continue doing business in the manner it was prior to the run? The company has the same people, the same assets, the same customers, the same profits.
Why do companies offer stock for sale to the market? It's to raise cash. Even after floating on the market, if a company requires cash badly, they can hold a secondary offering, or issue preferred stock.

Consider a company with a large amount of debt. If a company has a huge market cap - as a result of a good stock price - then in the event that it is unable to meet its debt obligations, then it can turn to the market for additional capital. The larger the market cap, the less dilutive, and the easier it is to obtain more capital.

So, if a company has $10 billion of debt, but $100 bn of stock - it's would be virtually impossible for that debt to default, as the company would always have the option of a stock issue. As a result, the company can get a pristine credit rating.

Now consider if the company has $10 bn of debt, but there is a loss of confidence in the business +/- short selling, and the share price collapses, so the market cap is now only $10bn. If the company can't find cash to pay its loans, WTF does it do? Additional stock issues will be catastrophically dilutive to stock holders, and issuing preferred stock will require an astronomical yield. The company is now at real risk of having to restructure its debt committments, or sell assets in order to restore cashflow - the result ends up being a credit downgrade, which makes further loans to expand business difficult.

However, even that is potentially not the end of a world for a company.

The big problem in the current market, and what prompted the near collapse of AIG, is derivative exposure. Derivatives are only worth what the other party to the derivative can pay. As a result, both parties must put up collateral, and the amount of collateral depends on credit rating. If the share price drops, then it could potentially trigger a credit downgrade, which would require additional collateral to be posted.

This is what happened to AIG. AIG has enormous highly leveraged derivative exposure - through their sale of credit default swaps; a type of insurance against default against debt, and a type of insurance which is critically dependent upon their own credit rating (how can you insure someone elses's debt, when your credit rating is worse than theirs?) The catastrophic fall in share price which had previously hidden the implicit risk in their leveraged position by a good credit rating, meant a credit downgrade. SUddenly, they received a demand for an additional $10 bn cash for collateral for their derivatives. They didn't have $10 bn. Ergo, they were fux0red.

The problem here is that companies that are highly leveraged - either through high levels of debt, or through derivatives, are critically dependent upon credit rating. Due to the way financial companies operate, they typically have high levels of leverage which can make them vulnerable to rampant short selling. Businesses with less debt, and more 'hard' assets are more likely to be resistant to damage from short selling.

What's made this worse, is the USG's decisions to wipe out the stock holders, even when this may not have been warranted. Again, in the case of AIG, they offered a temporary loan (at about 12% APR!), but in return for the loan wiped out the stock. They could have wiped out the stock only if the company defaulted on teh emergency loan - but no, they just wiped it out - like they did with fannie and freddie. This has set a bad precedent - essentially, any financial company that runs into difficulty will have its stock immediately totaled by the USG. Just look at it from a short seller's point of view. You short a company and it gets downgraded - the goverment now totals the stock, and you've turned a nice profit into a goddam bonanza.
 

Engineer

Elite Member
Oct 9, 1999
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700
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Originally posted by: ironwing
Originally posted by: Engineer
How about naked shorting? The ability to basically create as much stock as you want (nothing to back it up by borrowing) and sell it.
I don't see the difference between this and selling other types of futures contracts. Eventually, the seller is going to have to come up with the stock.
Maybe I'm missing something, but with regular short selling, you'll need to have the stock to be borrowed ready at the time of shorting. With naked, you can sell it, drive it down, and cover and never have a single share lined up for borrowing. Do enough of it at once, and you can literally create large amounts of "fake" shares sold on the market (since no borrowed shares are there to cover it). I'm not suggesting that an individual can do this, more of an institution or hedge fund. They could drive the stock into the ground on artificial shares...create a panic...and then profit in a major way. :confused:
 

nergee

Senior member
Jan 25, 2000
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Hey, when Bear Stearns was imploding, guess who the two biggest shorting houses of the stock
were........Goldman Sachs and Morgan Stanley.

Now these fuks are crying for protection....Biggest fusking den of thieves in the history of man, Wall Street is.....
 

Kuragami

Member
Jun 20, 2008
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As I said before I don't know a lot about trading but there is a huge elephant in the corner and it's called FTD (Failure To Deliver) which is basically an IOU for a stock. FTDs are so commonplace and are used so heavily that some argue that it's being traded as if it was stock. I'm not sure if this can tie into shorting a stock but my understanding is that FTDs are used by major financial firms to cherry pick a stock to collapse. While I don't know this for a fact I wouldn't be surprised at all if FTDs are used to help collapse stocks in conjunction with shorting.

Even just a year or so ago people claiming FTDs were a major financial concern were neatly placed into the tin foil hat drawer. Well apparently you can now add the SEC to that drawer as they went ahead and banned the use of FTDs when trading in the 19 federally backed institutions and did so through an emergency order. I think that was back in March but I'm not sure.
 

Mark R

Diamond Member
Oct 9, 1999
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Originally posted by: Kuragami
As I said before I don't know a lot about trading but there is a huge elephant in the corner and it's called FTD (Failure To Deliver) which is basically an IOU for a stock. FTDs are so commonplace and are used so heavily that some argue that it's being traded as if it was stock. I'm not sure if this can tie into shorting a stock but my understanding is that FTDs are used by major financial firms to cherry pick a stock to collapse. While I don't know this for a fact I wouldn't be surprised at all if FTDs are used to help collapse stocks in conjunction with shorting.
Normally when you sell stock, you have the shares to hand (either your own, or borrowed shares, if you are selling short). However, even though you have them to hand, the certificates (or electronic equivalent) don't actually get received by the buyer for 3 working days.

In the case of naked shorting, someone sells stock without having the shares to hand. Naked shorting is really only available to the biggest brokers and market makers - it would be most unusual for one of their customers, e.g. a hedge fund, or a retail client to be able to make a naked short sale. The problem with a naked short sale is that the share that has been sold doesn't exist. The seller, however, has 3 days to deliver the certificate.

However, consider the case of a company with rarely traded stock. A major investment bank naked short sells a few shares, which are promptly snapped up by buyers. They then need to buy or borrow real shares in order to deliver the certificates - but there are no sellers or shares available for loan. The shares therefore can't be delivered - so called 'failure to deliver'.

Technically, if you hold an FTD, it will be exchanged for a share as soon as the seller can find one. So, technically it has a value - and within firms, they can be traded a bit like stock.

FTDs are therefore a result of naked short selling. A high level of FTDs in a particular stock indicates a high level of naked short selling in a stock which is difficult to buy or borrow. Naked short selling is a technique that is used relatively frequently for bona fide market making - especially for options trades.

Let's say, that XYZ is a relatively small public compnay with relatively infrequently traded shares, and without any major long-term investors (who make shares available for shorting). A speculator wants to buy a ton of put options, in order to speculate on a fall in the share price. A market maker takes the order for options, and in order to cover themselves naked shorts the appropriate number of shares (something they are legally permitted to do). If they are unable to obtain shares, then this will cause a spike in FTDs.

Again, naked shorting has been used legitimately - although it isn't a technique for a healthy market, it just helps grease the wheels a bit. So you should expect to see a few FTDs here and there. However, a lot of FTDs may indicate something is wrong - e.g. there are a lot of people speculating that the stock will fall in price, and demand for borrowed shares exceeds supply. A sudden spike in FTDs can therefore be used to spot stocks that are being aggressively shorted - although by the time you start seeing the FTDs, you've already missed your chance to get a piece of the action.
 

Thump553

Lifer
Jun 2, 2000
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Wouldn't FTDs trigger off a short squeeze? (short sellers pushing price up when they buy to cover) Or are you saying that the FTDs never get filled?
 

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