Should Investors be Allowed to Short Shares?
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Short selling, a help or a hindrance? I am not talking about individual traders who enjoy the ability to short sell shares, I am referring to the existing shareholder. Whilst existing holders may not want anyone shorting their shares on a certain level, if the shares are shorted, and the shareholder has done their homework, then they should know when the shares have become good value and can buy more accordingly. Of course it is annoying when you want to sell the shares yourself and others are already forcing the price down.
It is interesting to see that the FSA are still hunting for someone to blame over the HBOS debacle. Perhaps they have not looked at the share price since the fateful 19 March. On that day the stock hit a low of around 400p but then a huge swathe of investors, small and large, bought in on the news that the Board was insisting that they had no problems. Even the Bank of England and the Financial Services Authority popped up to lend support. The price then rallied to 615p. Now, though, we know better. For the last 3 weeks or so that stock has been stuck in a 260p to 280p trading range. That is more than 55% down. Imagine if you were the trader buying at 615p. So who is the enemy of the investor, is it the short seller who in this case gave a very good early warning to anyone holding the stock or is the blame better attributed elsewhere.
Trying to force a share price lower via a bear attack can be a very dangerous activity for the participants as they can easily get caught the wrong way round. A badly conceived strategy can lead to a concerted move by Market Makers or a Stock Lending moratorium by major holders which can easily lead to a spike higher which forces the shorter to take a major hit.
Sudden takeover rumour also causes havoc for shorters...
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Looking at the Alliance and Leicester / Satander deal there has been a slightly different reaction. No one felt sorry for traders shorting via borrowing stock, placing CFDs, spread betting or otherwise. There was a lesson for everyone on the Friday that the possibility of a deal was announced. Some £150m was probably lost in just a few minutes by funds betting on continued weaknes. Alliance and Leicester shares were one of the most heavily borrowed stocks on the block. The price opened some 40% higher from the close on the Friday and traders would not have had a chance to get out of their positions. The shares rallied to well above the Santander offer. Anyone shorting was forced to cover their position at any price.
Readers should always remember that anyone can take advantage of being short via a huge array of instruments. Buying Put options, Selling Calls, selling stock and borrowing, Selling CFDs or, most simple of all, just selling a market via Spread Betting through companies like World Spreads or Spreadex. It is not just the larger funds who can take advantage of an inflated share price.
Whilst it can be a profitable form of speculation in today’s bear market, selling a share or commodity does have its risks. Just like buying shares and commodities have their risks.
"Should Investors be Allowed to Short Shares?" written by RThomas, last updated 25-Aug-2008
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