# Why do we allow short selling?



## Tyler Durden (8 January 2012)

> In finance, short selling (also known as shorting or going short) is the practice of selling assets, usually securities, that have been borrowed from a third party (usually a broker) with the intention of buying identical assets back at a later date to return to that third party. The short seller hopes to profit from a decline in the price of the assets between the sale and the repurchase, as the seller will pay less to buy the assets than it received on selling them. The short seller will incur a loss if the price of the assets rises (as it will have to buy them at a higher price than it sold them), and there is no theoretical limit to the loss that can be incurred by a short seller.




http://en.wikipedia.org/wiki/Short_(finance)

I was reading a news article a few days ago (can't remember where anymore) which said one particular country's stock exchange does not allow short selling. It made me think, why is short selling allowed anyway? It's purpose seems to be to drive a share price down, yet driving share prices down seems to be a bad thing for markets? 

So why do we allow it, and would we be better off if it wasn't allowed?


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## banco (8 January 2012)

Its defenders claim it facilitates price discovery.


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## chrislp (8 January 2012)

Tyler Durden said:


> http://en.wikipedia.org/wiki/Short_(finance)
> 
> I was reading a news article a few days ago (can't remember where anymore) which said one particular country's stock exchange does not allow short selling. It made me think, why is short selling allowed anyway? It's purpose seems to be to drive a share price down, yet driving share prices down seems to be a bad thing for markets?
> 
> So why do we allow it, and would we be better off if it wasn't allowed?





You should ask this question here.



This question has been brought up a few times; a search won't do no harm.







Same applies to you Banco.


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## explod (8 January 2012)

It is supposed to help order in the market, ie. keep prices under control and provide hedging at times of uncertainty, ie. ballance a portfolio.

To me it stinks and is just another method used by the financial industry and insiders to cheat the ordinary investor trader.

Many of the huge collapses in the US in the last few years has found the big side of town on Wall Street on the short side with the US taxpayer bailouts going into the pockets of the rich.

A topic well worth the newbies doing a bit of research on.  And I bet my comments draw flack from the usual traderonlycareaboutthemselves types.


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## AzzaB80 (8 January 2012)

No flak, just points out the uneducated.


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## wayneL (8 January 2012)

AzzaB80 said:


> No flak, just points out the uneducated.




Indeed


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## explod (8 January 2012)

AzzaB80 said:


> No flak, just points out the uneducated.




Please,, lead us to the light ?


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## wayneL (8 January 2012)

explod said:


> Please,, lead us to the light ?




This has been done several times on this forum. You can lead a horse to water, but you can't make it drink.


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## explod (8 January 2012)

wayneL said:


> Indeed




So you agree that it is okay for a Broker to lease/lend out someone else's shares, without that someone knowing about it so that they can then help to bring the price down and then give back the shares to the somebody at the lower price.

Cummorn, give me some ethical reasons ?


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## explod (8 January 2012)

wayneL said:


> This has been done several times on this forum. You can lead a horse to water, but you can't make it drink.




I will accept that you may need to use dumb persons terms so for the benefit of us idiots can you please explain again, and not with some convoluted reference.

Surely if it is all lagit and straight forward then your task will be easy.


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## Knobby22 (8 January 2012)

explod said:


> To me it stinks and is just another method used by the financial industry and insiders to cheat the ordinary investor trader.
> 
> Many of the huge collapses in the US in the last few years has found the big side of town on Wall Street on the short side with the US taxpayer bailouts going into the pockets of the rich.
> .




That is called insider trading which is illegal and wrong.
It's not the short selling that is the problem but the insider trading.

I'm not that keen on naked short selling in large amounts and would like to limit it to small investors. The reason is that the small investors is up agaisnt superfast computers and may be tricked in selling (hitting a stop)and not be able to buy back in before the price rises again.

Don't know how it could be done practically though. Standard short selling where you borrow the shares is OK by me.


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## skyQuake (8 January 2012)

explod said:


> So you agree that it is okay for a Broker to lease/lend out someone else's shares, without that someone knowing about it so that they can then help to bring the price down and then give back the shares to the somebody at the lower price.
> 
> Cummorn, give me some ethical reasons ?




Only small time weasly brokers do that. 

Real volume is from Prime Brokers/Custodians who first get a stock lending agreement from holders, and pay them interest/costs, then lend out the stock to the shorters.
Anything less is pretty much illegal. 

And finally, what if I wanna bet something is going down? Do I have to cross the spread and buy a put option? and let the marketmakers delta hedge with shorts instead?


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## Struzball (8 January 2012)

You could argue going long is a problem too by driving up prices meaning a bigger crash down to fair value..

I wouldn't mind being able to short sell my house, I could keep living in it, I wouldn't have to pay interest on my loan until I buy it back at a lower price down the track, and I'd end up with a cash profit (assuming house prices fall of course).  It would also help prospective buyers to know they aren't buying into an overinflated housing market.

If shares in XYZ are actually worth $40, allowing short selling won't suddenly make their real value $20.  However if the shares are only worth $20 in the first place, and a ban on short selling keeps their value artificially at $40, how does that help anybody?


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## prawn_86 (8 January 2012)

Struzball said:


> I wouldn't mind being able to short sell my house, I could keep living in it, I wouldn't have to pay interest on my loan until I buy it back at a lower price down the track, and I'd end up with a cash profit (assuming house prices fall of course).  It would also help prospective buyers to know they aren't buying into an overinflated housing market.?




Slightly off topic but i know Macquarie was working on an ETF of each of the capitals for RE housing prices. So in theory you could do it with that.

Haven't heard anything new about if/when it will be able to be traded though


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## explod (8 January 2012)

AzzaB80 said:


> No flak, just points out the uneducated.




What?

is it unneducated to point out that Wall Street cheats to take the money from the ordinary guy.

And being able to short with inside information does just that.


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## AzzaB80 (8 January 2012)

explod said:


> Please,, lead us to the light ?




Learn how markets work would be a good start. 

Maybe read a book or two, I'd start with this one:
http://www.amazon.com/Dont-Blame-Shorts-Sellers-Repeating/dp/0071636862

That is all I'm going to do for you. You work out the rest like I did.


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## explod (8 January 2012)

AzzaB80 said:


> Learn how markets work would be a good start.
> 
> Maybe read a book or two, I'd start with this one:
> http://www.amazon.com/Dont-Blame-Shorts-Sellers-Repeating/dp/0071636862
> ...




So its not that easy huh.

I have been trading stocks since 1969 so do not suppose complete ignorance.

Short selling, though legal is unethical.

Let those who can state simply, a case otherwise, contradict me.


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## AzzaB80 (8 January 2012)

explod said:


> So its not that easy huh.
> 
> I have been trading stocks since 1969 so do not suppose complete ignorance.
> 
> ...




If you don't want to do the work why should I. I couldn't care less


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## mazzatelli (8 January 2012)

skyQuake said:


> And finally, what if I wanna bet something is going down? Do I have to  cross the spread and buy a put option? and let the marketmakers delta  hedge with shorts instead?




hi explod, can you give us some of your insight regarding this question?


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## LostMyShirt (8 January 2012)

At the very least it adds liquidity to the marketplace. Considering it takes massive pressure on both sides of supply and demand to make a stock move, the added liquidity does not hurt.


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## Judd (8 January 2012)

LostMyShirt said:


> At the very least it adds liquidity to the marketplace. Considering it takes massive pressure on both sides of supply and demand to make a stock move, the added liquidity does not hurt.




And why does a stock have to move?  Aside from the the effort involved in driving all those cattle to market of course.


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## LostMyShirt (8 January 2012)

Judd said:


> And why does a stock have to move?  Aside from the the effort involved in driving all those cattle to market of course.




Sorry, I think you've misunderstood. No amount of short selling is going to drive a price lower. Having said that, if overall sentiment of a security drives the price higher, short selling is just stupid. I mean, go throw your money in the bin.

If you gather overall sentiment is going to lessen, then go short.

Why does a stock need to move? Well it doesn't NEED to, but people at times are willing to purchase securities at higher prices.


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## explod (8 January 2012)

mazzatelli said:


> hi explod, can you give us some of your insight regarding this question?




The fact that one *can bet *on something going down does put it in the realms of gambling and not the ordinary trading of goods for fair value.


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## wayneL (8 January 2012)

explod said:


> The fact that one *can bet *on something going down does put it in the realms of gambling and not the ordinary trading of goods for fair value.




In your view should short selling be banned in commodities futures also?


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## Judd (8 January 2012)

LostMyShirt said:


> Sorry, I think you've misunderstood. No amount of short selling is going to drive a price lower. Having said that, if overall sentiment of a security drives the price higher, short selling is just stupid. I mean, go throw your money in the bin.
> 
> If you gather overall sentiment is going to lessen, then go short.
> 
> Why does a stock need to move? Well it doesn't NEED to, but people at times are willing to purchase securities at higher prices.




My sincere apologies, LostMyShirt, my sense of humour is occasionally warped.  I was having a play on words.  Again, my sincere apologies. 

However, it is a fascinating subject. Still have an interest in the subject even though I gave trading away many, many moons ago for various reasons; the main one being associated with your nick.  Now I only place money in the sharemarket assuming I'll never see it again. Makes for a simpler and much less stressful life.

I don't believe that the tribes will ever reach a consensus on the shorting of shares.  I can appreciate the arguments for it but personally I am not in favour, especially naked shorts - there is a joke about that but I am not going to go there.

It becomes an attitudinal thing is some respects as to what people expect the share market represents, either a place where securities are traded or a reflection of human endeavour and intellectual progress where new companies and new products are provided an opportunity to grow.

Regards


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## LostMyShirt (8 January 2012)

Judd said:


> My sincere apologies, LostMyShirt, my sense of humour is occasionally warped.  I was having a play on words.  Again, my sincere apologies.
> 
> However, it is a fascinating subject. Still have an interest in the subject even though I gave trading away many, many moons ago for various reasons; the main one being associated with your nick.  Now I only place money in the sharemarket assuming I'll never see it again. Makes for a simpler and much less stressful life.
> 
> ...




Lol, sorry man I didn't even pick up that it was humour. I guess I'm a dull guy!

Well it is good to hear that you still remain in the market at least. Your trading style makes sense - given the right amount of time and analysis, profits will yield.

Personally I'm not a trader but the ability to short securities, in my opinion, is beneficial to the market. 

I don't know, I am not a Guru, but from what I've read it seems to be beneficial.


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## mazzatelli (8 January 2012)

explod said:


> The fact that one *can bet *on something going down does put it in the realms of gambling and not the ordinary trading of goods for fair value.




So say we see mis-pricing between Cth govt bills and Cth govt bill futures. To bring this mis-pricing back in line, we need to trade an arbitrage which will get the relationship back to fair value.

The transaction would involve for example shorting the govt bills and going long the bill futures. But shorting in this case would not be allowed?


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## Julia (8 January 2012)

explod said:


> The fact that one *can bet *on something going down does put it in the realms of gambling and not the ordinary trading of goods for fair value.



How does betting on something going down differ from betting on something going up?


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## young-gun (9 January 2012)

Julia said:


> How does betting on something going down differ from betting on something going up?




+1. everything to do with stocks whether it be long short options or any form of derivative is indeed a gamble, given that no-one can actually say with certainty(other than those with insider info) that they are definitely going to profit from their decision or position taken.

_gamble _- any of the below sound familiar?

v.intr.
1.
a. *To bet on an uncertain outcome*, as of a contest.
b. To play a game of chance for stakes.
2. *To take a risk in the hope of gaining an advantage or a benefit.*
3. *To engage in reckless or hazardous behavior*(im sure you all have)

v.tr.
1. To put up as a stake in gambling; wager.
2. *To expose to hazard; risk*

n.
1. A bet, wager, or other gambling venture.
2. *An act or undertaking of uncertain outcome; a risk:*

ok so you can educate yourself to minimise risk and attempt to maximise returns, but i can do that in black jack.


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## Tyler Durden (9 January 2012)

young-gun said:


> +1. everything to do with stocks whether it be long short options or any form of derivative is indeed a gamble, given that no-one can actually say with certainty(other than those with insider info) that they are definitely going to profit from their decision or position taken.
> 
> _gamble _- any of the below sound familiar?
> 
> ...




I think there are a lot of people who wouldn't consider the share market as gambling.


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## wayneL (10 January 2012)

Tyler Durden said:


> I think there are a lot of people who wouldn't consider the share market as gambling.




There are a lot of people using the market as a casino too, whether they realize it or not.

But in the truest sense almost everything in life is a gamble, from opening a business to trying to chat up the gorgeous woman whose tattooed monster of a boyfriend might just walk in at any moment.

But there are smart gambles and dumb gambles. 

Consider the casino itself. There are two sides to every bet. Casino patrons are playing against negative expectancy and unless the punter finds a way to reverse that, they are the dumb gamblers.

The house has a positive expectancy, long term they know that there is an overwhelming probability that they will make a gross profit. Are they gambling? That gross profit still has to be higher than their enormous expenses. So yes they are gambling that they can attract enough muppets to turn over enough bets to get a return on their investment.

Trading and even investing is no different.

If short selling is gambling, then so is going long. Each requires a higher sale price than buy price to turn a profit, only the order is reversed. In both cases a risk and the outcome is uncertain.

Investing for dividends? You have no idea whether the company can remain profitable or if so, whether it can maintain it's current level of profit and dividends. The directors may reduce or suspend the dividend at any time at their discretion, for any reason they see fit. That's a gamble. Perhaps an educated gamble in many peoples case, but still a gamble.

This is why smart traders and investors create plans to increase the probability of positive expectancy. Yes they are still gambling in the truest sense, but it's 'smart' gambling, just like the casino.

============

On short selling; Without short selling, many markets would cease to exist. 

There would be no futures markets, because for there to be a long position, a corresponding short position must exist. Producers and consumers of commodities would not be able to hedge their production.

There would be no functional options market. Ignoring that each long option contract requires a corresponding short, market makers would not be able to hedge their delta, vis a vis there would be no market makers willing to step up to take the other side of your trade. The option exchanges would become ghost town.

Also consider these points:

Banning short selling does not prevent normal sales and will not prevent precipitous falls in stock prices
There are many stocks for which you cannot short sell. Save for normally lower volumes, the price action is no different. They can get hammered too.
Every short must be bought be someone, so for every short sale there must be a willing buyer.
A normal sale may never result in another purchase, if someone sells a stock, they may never buy that stock ever again
A short sale however must ALWAYS result in a purchase at some point in the future, hence the phenomenon of short covering rallies.

I don't agree with naked short sales, I think they should be banned (and are in many jurisdictions) because they have the effect of artificially increasing the float, i.e. creating new 'shadow' shares not issued by the company. That creates imbalances.

However I firmly agree with covered short sales (stock is lent to the short seller) for the reasons above.

Look, there are many buffoons running around blaming short selling for the losses in their portfolio. That's bullshyte. If the shorters did manage to push prices down, value investors would rush in with ears pinned back.

Your losses are because you bought a pile of overvalued crap in moments of irrational exuberance and rational value has been restored.


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## nulla nulla (10 January 2012)

For the benefit of readers is it worth distinguishing between "naked short selling", "short selling borrowed shares" and/or "short selling through cfd's"? 
Also what about scale, large hedge funds versus Joe Bloggs daytrader?


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## sinner (10 January 2012)

It's pretty hard to get worked up over short selling on the ASX, if you take a look at 
http://www.asx.com.au/data/shortsell.txt

You can see short selling doesn't even make half of 1% of the float for all shorted stocks. Billabong being the highest % of float under short with Lynas not far behind. If I had to bet, I'd guess probably half those shorts are longs holding hedges from a higher price. Those are longs that would probably sell their shares if shorting wasn't allowed.


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## explod (10 January 2012)

> wayneL
> 
> Having another obnoxious attack Mr Plod?
> 
> ...





Thought I would move this quote over to the right place as directed.

In answer, not at all and believe you are not really seeing my point and if you do you resort to bluster when you disagree..

I can agree with some of the cases put up for short selling but as regulation over markets is poor to almost non-existent it enables the savvy to rob the rank and file.

In my view.


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## skc (10 January 2012)

sinner said:


> It's pretty hard to get worked up over short selling on the ASX, if you take a look at
> http://www.asx.com.au/data/shortsell.txt
> 
> You can see short selling doesn't even make half of 1% of the float for all shorted stocks. Billabong being the highest % of float under short with Lynas not far behind. If I had to bet, I'd guess probably half those shorts are longs holding hedges from a higher price. Those are longs that would probably sell their shares if shorting wasn't allowed.




When short selling was banned during the GFC and more recently in Europe, it didn't stop the share market from falling further. Short selling can't drive prices down forever, nor does short selling changes the fundamentals of a company. JB Hi-Fi was top 10 most shorted stocks for a long time last year, yet I somehow doubt that the shorting caused the reduced sales and profits...

It's easy for one to blame short selling for their trading/investment losses... but I'd like to challenge anyone who can point to an example where a company is fundamentally changed by short selling activity. The only exception may be capital raising activities - but in most cases prices are actually manipulated up before a capital raising announcement anyway.

Short selling does cause prices to be lower, but that's no different to long buying causing prices to be higher. "Evil market manipulators" can short a stock, drive prices lower, so they can buy at a lower price. But the same evil market manipulators can also long a stock, drive prices higher so they can sell at a higher price. Does that offer grounds for banning long buying?

And for those who opposes it from an ethical ground, because short sellers gain at the expense of long buyers. Well, for a long buyer to profit you are doing so at the expense of whoever it was that sold you the share, as they forego their profits. It's a zero sum game and one person's gain is always someone else's loss. Shorting is no more ethical or unethical than long buying.

Let's not forget that the sharemarket is by and large a secondary market... "investing" in shares doesn't actually mean that goods are produced or jobs are created. So there is no moral high ground from there for the long buyers either.

There really isn't that much difference between long buying and short selling in terms of their function and moral. The only difference is the order to which buying and selling happens.


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## Timmy (11 January 2012)

Short selling should be encouraged and fostered. Improves liquidity, improves risk management. 

ps. Chinese authorities are making shorting easier:


> China is poised to unveil measures to bolster the country's nascent short-selling industry in an effort to deepen its capital markets, according to securities officials and fund managers.....Defenders of the practice say it increases liquidity and provides income for shareholders who are willing to lend their securities.



From the FT
http://www.ft.com/cms/s/0/f9356138-36aa-11e1-9ca3-00144feabdc0.html#axzz1j3verjFM


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## wayneL (11 January 2012)

explod said:


> > wayneL
> >
> > Having another obnoxious attack Mr Plod?
> >
> ...




Let's get my comments into context shall we Plod?

It was in reply your reply tech's comment about the silence is deafening" viz:



> Yep, its a bit like me *stirring the dogs* on the "short the market thread"



It's nothing to do with "bluster".

That comment was inaccurate, offensive, obnoxious and monumentally hypocritical, as we've come to expect from you.

You haven't answered one question here, just silence until I poked you in the ribs about it, and not really answers, just a grudging acceptance that you have no answers.

Try treating people with respect instead of referring to your fellow forumites as "dogs". It is derogatory and nasty and against the spirit of the rules of the forum.


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## skc (25 September 2012)

Here's a story on a ASIC review of the short selling ban during the GFC.



> ''The ban on short-selling may have exacerbated market volatility. It also potentially inhibited price discovery in the market and may have reduced market liquidity.''






> ''The short-selling measures potentially contributed to a number of other outcomes, which had negative impacts on the efficient operation of the Australian market. These included higher bid-ask spreads, lower turnover and encumbered price discovery.''






> ''Negative impacts may have been exacerbated by the length of the period of the Australian short-selling ban compared with those in other highly developed markets.''




http://www.smh.com.au/business/little-gratitude-for-the-ban-that-saved-the-bacon-20120924-26hec.html


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## Superb Parrot (25 September 2012)

skc said:


> There really isn't that much difference between long buying and short selling in terms of their function and moral. The only difference is the order to which buying and selling happens.




If you short (sell) your own shares, no problem, but selling a borrowed share ????.... why not short property ?


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## Trembling Hand (25 September 2012)

Superb Parrot said:


> If you short (sell) your own shares, no problem, but selling a borrowed share ????.... why not short property ?




You cannot short your own sheres that is just selling them so you have no position!!


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## Huskar (25 September 2012)

skc said:


> Here's a story on a ASIC review of the short selling ban during the GFC.
> http://www.smh.com.au/business/little-gratitude-for-the-ban-that-saved-the-bacon-20120924-26hec.html




You forgot to add the completely contradictory report that ASIC have "vowed" to reimpose short selling bans if necessary. 

http://www.smh.com.au/business/asic...n-in-chaosfighting-armory-20120924-26hdz.html

Talk about hypocritical!

Not only does short selling add to market liquidity I am a firm believer in short sellers acting as an important market mechanism. They are usually the first to reveal fraud and failure.

And a company blaming its declining share price on short sellers is usually a good red flag for a potential short...


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## Superb Parrot (25 September 2012)

Huskar said:


> You forgot to add the completely contradictory report that ASIC have "vowed" to reimpose short selling bans if necessary.
> 
> http://www.smh.com.au/business/asic...n-in-chaosfighting-armory-20120924-26hdz.html
> 
> ...




I am still trying to get my head around shorting.....why not let the owners of those shares sell them if there is suspicion about the company ? There are plenty of institutional investors that hold the shares ready to hit the sell button. Why force an unnatural volatility (read a very rapid drop in price) in the name of that weasel term "price discovery"?......no, it is all about liquidity, something for the day traders to play with.


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## tech/a (25 September 2012)

> but selling a borrowed share ????....




The Owner of the share recieves a premium.
The borrower sells the share with the intent of buying it back at a later date and pocketting the difference.
Hence giving back the owner his shares.
Standard practice for shorting.

Now pray tell how do I short a house?
Subdivide it?--kidding

Only certain shares can be shorted unless they are CFD's.
Check the ASX site for more info


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## Joules MM1 (25 September 2012)

Superb Parrot said:


> ....no, it is all about liquidity, something for the day traders to play with.




everything is about liquidity......daytraders merely take the advantage of a mechanism that other's don't or can't because they either dont know how to, have liquidity constraints or time constraints.......everything is about liquidity for a trader


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## Superb Parrot (25 September 2012)

tech/a said:


> The Owner of the share recieves a premium.
> The borrower sells the share with the intent of buying it back at a later date and pocketting the difference.
> Hence giving back the owner his shares.
> Standard practice for shorting.
> ...




Thanks for your patience, I am not necessarily against it, just trying to get a handle on its place in the scheme of things. I will check the ASX site.

Short a house ?, sell it pay the owner a premium, buy it again and hand it back....yes, too illiquid, but I was thinking that it was only another asset class.

 Sydney residential housing market sure needs some price discovery !


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## wayneL (25 September 2012)

Broken record time:

For every sale, short selling does not cause prices to go down more.

EVERY traders who short sells MUST buy at some point in the future.

Whereas a trader who simply sells out a position may never buy that stock ever again.

Short selling makes a stock rally harder because of shorters cover their position.


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## Joules MM1 (25 September 2012)

wayneL said:


> Broken record time:
> 
> For every sale, short selling does not cause prices to go down more.
> 
> .




this is incorrect....."every" is an incorrect assumption....in some cases short sales are used especially to add sell liquidity, to add weight of numbers and the inability or the lack of desire for buy-side liquidity to come up and swamp the selling allows price to decline.....that doesnt mean there arent a ton of buers below, afterall, in some uptrends the buyers think why rush there's selling and does it matter if i'm buying from someone who's closing a long or someone who's opening a short? 

The buyers perspective is often completey different to the seller....strange that......

an accummulator might look at an equities ratio of stock at short sale.....if shorts are at a peak near the bottom of a trend some buyers might wait for a sign that there's selling exhaustion, rush in and cause a squeez.....in that instance their lack of participation to push the bid is the reason price is declining inclusive of extra selling.......


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## john12 (22 November 2012)

short selling is a good thing because it provides us with more opportunities to make money, which is what we are all trying to do isnt it?  short sellers can lose too, if the price rises and they hold on hoping it goes down ...


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