Cafe Talk | Talking Points Memo | Short-sellers profiting

From: Cafe

Short-sellers profiting

By Donal Fagan - July 16, 2008, 8:04AM

Short sellers have best month in more than 7 years

The Strunk Short Index, which tracks a handful of managers that specialize in short selling, jumped 10.47% last month. That was the best performance since March 2001, when the index surged 12.45% during the dot-com bust.
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In a short sale, traders sell borrowed shares, hoping to buy them back at a lower price and return them to the lender. The difference is kept as profit.
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Short-sellers are often blamed when a downturn in the economy or a financial crisis pushes stock markets lower.

Short-sellers get blamed for falling prices just as commodity traders are getting blamed for rising oil prices. It is sort of like blaming the vultures for dying of thirst.

Comments (10)

Shorts (especially short hedge funds) team up to attack companies and destroy them. They spread rumors, try to cause panic, and cause companies to fail and millions to lose their jobs so they can make money. Vultures eat only the dead, shorts kill companies (like Bear Stearns). The SEC stupidly removed the uptick rule in July 07, and the markets immediately started crashing. Not a coincidence. The markets were designed so companies could access capital and investors could access company profits, they were not created so speculators could drive companies out of business and bankrupt investors to make a profit.

Posted by theCleverBulldog
July 16, 2008 8:13 AM | Reply | Permalink

The life of a short-seller is a hard one — especially when markets turn sour and people look for someone to blame

http://www.economist.com/displaystory.cfm?story_id=11591349

Posted by Donal
July 16, 2008 9:15 AM | Reply | Permalink

Shortselling is essential for achieving price parity in financial markets. Sometimes it is abused, so the abusers should be harshly punished and basic regulations like banning naked shorting and the uptick rule should be enforced. But short-selling in and of itself is not the crime.

Posted by Kinkistyle
July 16, 2008 8:53 AM | Reply | Permalink

OK, it's easy for me to understand why naked shorting is bad. But could either you or theCleverbulldog (or anyone who knows) explain why the uptick rule is necessary? (I'm not arguing that it's not, I'm just saying I don't get it.)

Posted by Ben
July 16, 2008 11:07 AM | Reply | Permalink

Here's a definition from an online glossary:

The uptick rule was a trading regulation that applied to US stock markets to prevent entering a short trade unless the previous trade was an uptick (a trade at a higher price than the preceding trade). The uptick rule was implemented by the US SEC (Securities and Exchange Commission), to limit the influence that short trades could have on the stock markets (in other words, to keep the US stock markets from declining). The uptick rule was removed on July 6th 2007, so from that date onwards, short trades could be entered at any time regardless of whether the previous trade was an uptick or downtick.
Uptick Rule Requirements

When the uptick rule was in place, a short trade could only be entered after a trade that caused the last price to increase. For example, if there were a sequence of trades at 125.67, 125.66, and 125.65, no short trades could be entered, but if the next trade was at 125.66, short trades could then be entered.

Uptick Rule Controversy

Some traders (primarily buy and hold investors) believe that the uptick rule was a good restriction, and that its removal has caused the US stock markets to trade erratically because of an increase in volatility. This is a flawed theory, that is based upon the belief (or hope) that stock markets should only go up. In reality, the removal of the uptick rule has evened out the volatility, because short trades can now occur at their natural times, instead of all happening at once (i.e. in groups every time there was an uptick).

The uptick rule was just a way of trying to keep the US stock markets up artificially. The European markets have never had an uptick rule (nor anything similar), and these markets have never had a problem with either volatility nor erratic trading. With the removal of the uptick rule, the US stock markets are able to trade according to their natural market dynamics.

http://daytrading.about.com/od/stou/g/UptickRule.htm

I gather the uptick rule dates from 1929 and was intended to prevent rapid declines, but I have to wonder if, over time, the rule, in combination with amateur investors, has contributed to market bubbles. Amateur "Buy and Hold" investors count on markets that move steadily up while professional speculators can profit no matter which direction the markets are moving.

Posted by Donal
July 16, 2008 11:41 AM | Reply | Permalink

By "amateur buy and hold investors", I gather you mean Warren Buffet?

Really, it comes down to whether you think the markets are for investing or speculating, and do you think it is good to set up a system that rewards people for destroying businesses and causing people to lose their jobs.

Posted by theCleverBulldog
July 16, 2008 12:04 PM | Reply | Permalink

Investment is speculation, and I imagine Warren Buffett knows that. The highly-leveraged Bear Stearns was frequently shorted before and after the rule change. As a hedge fund, it was inherently speculative. I only regret that they used my tax dollars to bail out people that were taking huge risks anyway.

Posted by Donal
July 16, 2008 1:00 PM | Reply | Permalink

Well, with that rule in place, if a stock is 'under attack' by shorts, they can not continue to short it unless it moves up in price. It can fall because longs are bailing out, but shorts can't accelerate the downfall. This prevents a short attack driving a stock to zero. If longs are not selling, the short activity is halted, and can only resume as people buy.

Posted by theCleverBulldog
July 16, 2008 11:47 AM | Reply | Permalink

OK, good responses from both the pro and con. At least I have a better understanding of why both sides care.

Posted by Ben
July 16, 2008 11:51 AM | Reply | Permalink

I am a "buy and hold" value-based individual investor, so keep in mind that I am biased.

I am of the opinion that intentional downward manipulation of stock prices by institutions is much more dangerous than upward manipulation. "Pumping and dumping" on irrational exuberance to fleece the small investor -- while immoral -- never directly caused a run on a bank. But panic selling caused by the manipulation of a cadre of heavily-funded institutions can and that doesn't affect just small-time investors but also your grandma and grandpa.

That being said, I don't believe the removal of the uptick rule is the cause of malicious short-selling -- since it was also done with an uptick rule in place -- but I certainly think it just makes it easier to do. Why make things easier for "bear raiders"?

Posted by Kinkistyle
July 16, 2008 12:45 PM | Reply | Permalink

Short-sellers profiting

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