Scenario one: you borrow some money. You exchange the money for shares. The shares go up, you exchange the shares for more money than originally, and so pay back the loan and you have a profit. If you get it wrong, they go down and you lose instead.
Scenario two: you borrow some shares. You exchange the shares for money. The shares go down, you exchange the money for more shares than originally, and so pay back the loan and you have a profit. If you get it wrong, they go up and you lose instead.
Symmetrical, yes? Very pleasing.
Indulge in #1, and no-one cares. Indulge in #2, and everyone hates you. And bans it.
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Do you really not understand why?
Driving down the price of stocks affects the entire market - and leads to companies failing.
Selling a stock puts downward pressure on the price of that stock; which harms the ability of the company to borrow money. But some companies are overvalued, they have crappy management and shouldn't have easy access to other people's money.
I made a bit of money shorting a company's stock that was way overvalued because of lazy press coverage of some bullshit lawsuits taken against a few and threatened against many. I knew their claims were bullshit. The press was claiming otherwise and the stock was soaring. I publicly stated that their claims were bullshit on the yahoo forum for the stock and then I put my money where my mouth was -- I borrowed some of their stock and sold it.
Initially, I rode the stock price from $14/share to $22/share, putting me $8/share in the hole if the entity from whom I borrowed the stock asked for it back, which they can do at any time with a few days notice, or if I no longer had enough collateral in my brokerage account to cover the debt. Shorting a stock is very risky -- much riskier than buying a stock or buying options. You can mitigate the risk by buying call options at your bail-price. Nobody was writing options on this stock, though. In the end, I covered at $4 about three years ago. The useless company is still trading, having lost all of their lawsuits -- they closed today, still overvalued IMO, at $0.14. SCOXQ.PK (used to be SCOX.)
The problem isn't that companies fail -- it's that useless companies don't fail quickly enough and suck up capital that ought to go to companies that add value to the world. Shorting helps this situation; and it is no more prone to abuse by market manipulators than standard trading. Banning it is ridiculous.
Shorting is OK. The real problem is naked shorting:
Shorting is a normal part of markets and fundamentally is not any less moral than going long -- you've borrowed the shares and are at risk if things go the wrong way. Naked shorting, on the other hand, is pure manipulation.
Naked shorting already is illegal (in the U.S. -- don't know about the UK) but regs against it have been indifferently enforced. Banning all short selling is overboard.
[Hmmm, naked shorting is a new one on me. Isn't the problem that people are prepared to give you money in exchange for something you don't have? How is that ay different to accepting money for, say, a car that you don't have? -W]
As Daniel Drew said about short sellers in a corner:
He who sells what isn't his'n
Must pay the price or go to prision
Which points out (as others have done) the major difference between going long and short, the risk on the long side is that the price goes to zero. There is no limit on the risk on the short side if you are naked.
Yeah, all of a sudden the idea that The Market is the best means of setting prices goes out the window. Gotta have a scapegoat - after all, it couldn't be because we've modelled our entire economy on Ponzi principles, could it?
Quote William (I'm assuming):
In the moral sense, it isn't any different. And like Raymond Arritt said, it's manipulation and illegal in the US. I have no problem with the regs against naked shorting.
But the problem is not that the buyer is willing to give you money for something you don't have -- the buyer never knows. Her account still shows the shares. After 3 days, her broker starts pinging your broker (who more correctly corresponds to your "people prepared to give you money") with failure to deliver notices. How long that situation stands depends on a number of factors. And it ain't going to happen with an etrade account.
If shorting is done on margin by someone with deep pockets the leverage can be huge, of course.
[But so can longing -W]
Qouth the Rabett:
Generally speaking, "margin" is finance-speak for"credit" so I think of all short sales as being done on margin. That said, the margin leverage of a short versus a long play is weighted by the fact of the higher risk in the short position. Selling 1000 shares short is a stronger statement than buying 1000 shares on margin. In my personal risk calculations, I weigh it as an order of magnitude stronger. In valuing the market for a stock, I look at the short-to-long ratio.