Short selling the argument

The reason why the concept is difficult to grasp is because it is often assumed traders are selling something they do not have (in the hope of buying it later at a cheaper price point).  In the 'real' world, you cannot sell someting you don't own.

Apparently traders can cover the sell with a buy option... but where do they get these buy options, and why would a stock holder (pension fund, whatever) commit to a sale without an agreed price, knowing there is the potential for the buyer to contribute to a run on the stock price. 

I suspect the answer is that they sell blind in the hope they drive the sale price down and then are able to buy the stock at the cheaper price.  If too many people participate in this selling, then there can be a shortage of available stock to purchase when the books need to be balanced and that caused a big bounce up again.

Isn't it the blind shorting that is being curbed?

They always say that that traders dont care a damn which way the markets are moving (its not their money) just so long as they know the direction so they can make their commissions on every trade.

Well thats only part of the story. For years i worked in Jobbing and market making firms and managing short selling was a normal daily operation.

First lets get this clear! No bank or market making firm sells short on idol speculation. Selling short is normally part of a strategy and entails covering the short with an option or other derivertive. Naked shorts are managed very closely by firms as the potential loss is ,well as wee used to say "The sky is the limit". For this reason heads of dealingdesks/rooms and the board monitor short selling very very closely.

There is no such thing as dealers driving the price down by shorting the market. This is market abuse and there are severe penalties for this practice.

To cover settlment of the bear sale the firm will borrow the stock from a investing Institution and pay for the privalage a percentage but also provide acceptable collateral that is margined. There is a mark to market each day and sometimes during the day if there is severe volatility. So no settlment risk

There is a risk taken by the firm that is going Bear and that is why they buy put options or the like to reduce their risks

Now there are now a number of OTC products that allow people or firms to effectivly short the market and it this area that i believe needs closer regulation and management

The Post Trade Forum will be debating this throughout next year and on the Post Trade Forum group on LinkedIn

That's good education.

Makes it sound like there are no gekko-esque dealings in the short selling world?  But the markets are fickle and don't really seem to reflect real demand at all, just following the 'pack'.  Its definitely not a place for the casual amateur trader and we have to face facts that you need to be on the inside to play.

Companies can 'create value' but at the end of the day it is the markets that arbitrarily decide whether that value is realised in the stock price.

Nice summary Gary - many people have been asking about 'evil' short selling, yet few seem to understand its importance and that it is an ingrained and invaluable tool in the market.

The fact that it provides liquidity and feeds the entire business of securities lending, repo's and collateral management seems to pass by many of those in the industry.

Agreed on the fact that regulation needs to catch up with some of the shadier OTC practices - these do the greatest damage by introducing unnecessary volatility and shaking confidence.

The 'evil' part of the discussion should be around the political posturing going on, and that knee-jerk reaction and regulation will probably do more damage to the market and send confidence down further.

Thanks for the comment and i agree with you. I am having a ongoing argument on the CISI Group on LinkedIn and its amazing how people have been emotional on this subject. However they are not proffesional people with much understanding of markets or short selling just missguided by politcians and the rather panic mood its created 

Still haven't heard a convincing argument for allowing short selling (except for market makers).

Imagine you're got to explain this a teenager - come up with a scenario or story where this makes sense.  You say it increases liquidity, how is that and what would be the consequences of not having short selling?