The Truth About Naked Shorts

There's been a lot of information and misinformation about short selling recently. Please allow me to bring you up to speed and bust some myths along the way.

Myth No. 1: Shorts should be shot
Many investors love to hate short-sellers because they see them as people who are rooting for others (companies and investors) to fail. What they're missing is that short selling is an integral part of a well-functioning market, since it allows market participants to express their view that a stock is overpriced. Without short sellers, the market would be inherently positively biased, and stocks would be priced less efficiently.

On top of that, some short sellers are outstanding stock analysts who have a good eye for fraud, mismanagement, or aggressive accounting. Take Jim Chanos of Kynikos Associates, for example, who was one of the first (and only) investors to call Enron out for its fuzzy accounting. If only more investors had listened to his arguments instead of those of Ken Lay and Jeff Skilling.

With that out of the way, now we can make progress.

Naked Short Selling 101
If you read a finance textbook, it will tell you that in order to sell a stock short, you borrow shares and sell them on, with the understanding that you must replace the loaned shares by purchase in the open market at a later date (hopefully, at a lower price).

That's the theory.

In practice, things are a little more fluid. Investors are not required to borrow the shares first before selling them, but they must have a reasonable expectation that they will able to locate shares they can borrow in order to be able to deliver on them to the buyer on settlement. Investment banks (remember those institutions?) have stock loan desks that specialize in going out into the market and locating shares for investors that want to go short. In fact, lending shares to hedge funds is a very big, very lucrative activity for the banks.

Selling shares that you haven't borrowed is known as a "naked short selling." You might have heard the term being bandied about in the press, since the practice has elicited much controversy and disinformation during the current crisis.

Myth No. 2: All naked short selling is illegal
This myth is unfortunately widespread, but it's simply false.

Nonetheless, critics argue the tactic allows hedge funds to launch speculative "attacks" on a stock, unfairly manipulating prices downward to profit from their drop. According to this line of thought, short sellers were instrumental in bringing down Bear Stearns (acquired by JPMorgan Chase (NYSE: JPM  ) in March) and Lehman Brothers (NYSE: LEH  ) (filing forbankruptcy).

What the critics are actually referring to is what the SEC describes as "abusive naked short selling," in which (a) short sellers sell shares they have not borrowed, and (b) are unable to deliver those shares on the settlement date of their sale. The SEC wants to eliminate abusive naked short selling through a series of measures that took effect on Thursday, which penalize failures to deliver borrowed shares at settlement. In addition, on Friday, the SEC banned all short sales of 799 financial stocks until Oct. 2, and increased the reporting burden for short sellers.

George Soros' principle of reflexivity and financial stocks
Why the comprehensive ban with respect to financials? Because those stocks may be particularly vulnerable to short selling. Why? George Soros' principle of reflexivity is at work here; Soros argues that a feedback loop enables investors' perception of a financial stock's intrinsic value to ultimately affect that intrinsic value. That might sound a bit "loopy," so I'll explain.

For companies outside the financial-services industry, a sharp and sustained drop in share price may reflect the market's negative outlook regarding a company's future prospects, but it is doesn't threaten the viability of the company in and of itself.

The same can't be said for many financial institutions, because they are highly leveraged and -- in the case of investment banks, for example -- they rely on short-term funding to do business. Under those circumstances, a massive drop in share price can irreparably damage the confidence of a firm's lenders and its customers, eventually producing a run on the bank.

We have watched that phenomenon raze the financial landscape in dramatic fashion. The most recent victims were Merrill Lynch (NYSE: MER  ) , which fell into the arms of Bank of America (NYSE: BAC  ) last weekend, and Fannie Mae, Freddie Mac and AIG (NYSE: AIG  ) , all three of which were nationalized to avoid failure. Finally, the fear of a run on the bank pushed Goldman Sachs (NYSE: GS  ) and Morgan Stanley (NYSE: MS  ) to become bank holding companies.

Abusive naked short selling should be eliminated, but…
Abusive naked short selling is not a normal or healthy part of a properly functioning market. Still, I'm a little uneasy with the ban of all short sales of financial stocks, which looks a bit heavy-handed. More importantly, regulators (and investors) shouldn't let the issue of short selling blind them to the fact that the massive credit problems that banks, broker-dealers and mortgage companies are dealing with are self-inflicted. Short-sellers didn't cause the credit crisis.

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Alex Dumortier, CFA has no beneficial interest in any of the companies mentioned in this article. JPMorgan Chase and Bank of America are Motley Fool Income Investor recommendations. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.


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  • Report this Comment On September 22, 2008, at 1:37 PM, carstenjansing wrote:

    maybe you can tell about the economic value of short sales?

    Liquidity is not one, as market makers should be able to short (short term only) for liquidity reasons.

    What is the economic value to let the public short shares?

  • Report this Comment On September 22, 2008, at 1:44 PM, ssg13565 wrote:

    You did not mention the uptick rule.

    Financial companies are not the only ones that suffer from attacks on their stock prices.

    Some companies get taken over in hostile takeovers because of attacks on their stock price.

    You also make a number of assertions that you do not back up with any evidence.

    Other than that, you wrote a fine article.

  • Report this Comment On September 22, 2008, at 2:03 PM, grateful4info wrote:

    Thank you so much for finally explaining this properly. I scoured the net last week for an explanation on how betting a stock will go down could cause the stock to go down. Sounded like easy money, too easy to be believable. The articles I came across all neglected to mention anything about the particular vulnerability of financial institutions' cash flow to investor perception. I had heard this explanation on CNBC in passing and have been looking for it in writing to reinforce in my brain. Thanks.

  • Report this Comment On September 22, 2008, at 2:14 PM, RRGY2K wrote:

    Price is supposed to be determined by supply and demand. Price integrity is lost when fictitious sales are made for shares that are "borrowed" (creating 2 owners for the same share).

    "Sharp eyed shorts cull the herd", somehow a matter of public service in the mind of shorts, is a silly argument. Culling the herd is preferred more by mountain lions than ranchers, and ranchers, unlike mountain lions, produce something valuable in the marketplace. And yes, they shoot mountain lions for attacking cattle!

  • Report this Comment On September 22, 2008, at 2:27 PM, ricblue wrote:

    If short sellers are required to actually

    borrow the stock for each and every trade, bear raiding would be greatly diminished. Owners of shares held in

    "street name" should then have more control. They could ask that their shares not be loaned out for shorting.

    This naked shorting is a recent abuse

    and needs to be fixed!

  • Report this Comment On September 22, 2008, at 2:51 PM, TMFAleph1 wrote:

    ssg13565,

    Thanks for your comment.

    Unfortunately, it's difficult to discuss all the technical aspects of short selling, such as the uptick rule, in a 900 word article.

    My articles are fully footnoted when I submit them, but the footnotes aren't included in the version that appears online.

    What are the assertions that you wish to see backed up with evidence?

    Alex Dumortier (XMFMarathonMan)

  • Report this Comment On September 22, 2008, at 3:08 PM, TMFAleph1 wrote:

    RRGY2K,

    Borrowing shares doesn't create two owners. Furthermore, I'm not sure how you define 'price integrity', but I think your assertion that it is lost as a result of short selling is probably incorrect.

    Here is a quote from a related paper on this topic:

    "Although the directional effect of short-selling constraints on market valuation is less clear, the preponderance of the theoretical and empirical evidence seems to suggest that increased short selling constraints is associated with less efficient price discovery, lower market liquidity, and higher costs of capital."

    'Capital Market Governance: How Do Security Laws Affect Market Performance?' Hazem Daouk (Cornell University), Charles M.C. Lee (Barclays Global Investors) and David Ng

    (Cornell University).

    http://papers.ssrn.com/sol3/papers.cfm?abstract_id=702682

    Alex Dumortier (XMFMarathonMan)

  • Report this Comment On September 22, 2008, at 3:12 PM, TMFAleph1 wrote:

    carstenjansing,

    Thanks for your comment. For the economic benefits of short selling by professional and individual investors, please see my previous post. Note that restricting short selling to market-makers would by definition be an enormous constraint on short selling.

    Alex Dumortier (XMFMarathonMan)

  • Report this Comment On September 22, 2008, at 3:42 PM, darnoldfool wrote:

    I didn't like several aspects of the article.

    First, after reading it, I still wasn't sure whether or not it is a naked short sale when the average person on mainstreet shorts a stock? If the average person shorts a stock, does his or her broker borrow the stock in the name of the seller? Can the broker complete the sale “naked” if they choose? Would the seller know?

    More importantly, the article leaves the reader with several impressions that may be half truths.

    First, is the statement that “the massive credit problems that banks, broker-dealers and mortgage companies are dealing with are self-inflicted’ . That is only partially true. The government played a role in creating the problem by:

    - pumping too much money into the system for Y2K and 911;

    - having no plan to get the excess money out when the crises passed;

    - gutting the regulations, so the excess money could be handled/manipulated secretively.

    Secondly, the article seems to imply that regulators are blameless when it states “… regulators (and investors) shouldn't let the issue of short selling blind them to the fact that…”. Regulators may be helping fix the problems, but regulators are also share in the blame. They could have helped avert the problem by exercising their regulatory mandate, but instead chose to look the other way while collecting their paychecks. Regulators are included when the political candidates chant their mantra that “Washington is broken”.

    I don’t believe we will get the best fix for the problems if we don’t understand and deal with all the root causes. If we are going to assign blame, and I think we should, let’s be all inclusive. The reader is left with the assertion that the short sellers didn’t do it, and the banks did do it. Blame, however, extends beyond only the banks.

  • Report this Comment On September 22, 2008, at 10:25 PM, EBStroke wrote:

    I would like to go back to the first comment (by carstenjansing)

    "What is the economic value to let the public short shares?"

    You stated the following:

    "What they're missing is that short selling is an integral part of a well-functioning market, since it allows market participants to express their view that a stock is overpriced. Without short sellers, the market would be inherently positively biased, and stocks would be priced less efficiently."

    There are at least four ways that an investor to express that a stock is overvalued:

    1. first, simply do not buy the stock

    2. express your opinion to the media press or to the blogisphere (to a world wide audience)

    3. hold the Board of Directors and the external auditors responsible for the integrity of the company's books.

    4. Initiate a hostile takeover

    There are probably other methods, but few would enable the investor to make a profit in the process.

    So again: "What is the economic value to let the public short shares?"

  • Report this Comment On September 22, 2008, at 11:37 PM, TMFAleph1 wrote:

    EBStroke,

    Thanks for your comment. Please refer to the paper I cite in one of my previous posts.

    Note that the methods (2.) & (3.) that you cite are tactics that are sometimes used by short-sellers in conjunction with their short positions. If investors take the time and effort to perform (2.) & (3.), I see no reason why they shouldn't do it in the pursuit of financial gain -- investing isn't a charitable pursuit.

    Finally, method (4.) is a no-go -- it would be the height of irrationality to launch a hostile takeover of a company with an overvalued stock. Undervalued, yes, but certainly not overvalued.

    Alex Dumortier (XMFMarathonMan)

  • Report this Comment On September 23, 2008, at 4:18 AM, carstenjansing wrote:

    XMFMarathonMan,

    thanks for your answer, you may also look to other papers

    (www.ccfr.org.cn/cicf2008/download.php?paper=20080115044238.P...

    that find the contrary.

    So instead of paper wielding, maybe you would come up with your own thinking ;)?

    I agree that some sort of short selling (for short term liquidity purposes) should be allowed to restricted and controlled entities, but not to the public.

  • Report this Comment On September 23, 2008, at 4:21 AM, carstenjansing wrote:
  • Report this Comment On September 23, 2008, at 8:41 AM, dwscho wrote:

    Thanks for your very interesting article. Proponents of short selling always state that it's an integral part of a well functioning market. They argue that without the ability to short sell, stocks would simply spiral upward. However, it seems unlikely that would occur as investors who fear a stock has gotten ahead of itself have the option to simply sell their position. What is most disturbing about shorts, is the practice of herding which can bring down a stock relatively quickly. It seems like it's a self dulfilling prophecy when shorts gang up on a company and drive the value down. I for one have difficulty buying the shorts argument. Thanks again for addressing this touchy subject.

  • Report this Comment On September 23, 2008, at 8:45 AM, TMFAleph1 wrote:

    carstenjansing,

    Thanks for your comment. Ignoring existing empirical results would be foolish and I'm afraid I don't have time to re-invent the wheel in order to respond to comments and questions.

    However, "paper wielding", as you derisively refer to it, doesn't exclude independent thought.

    For example, by looking at the paper you cite, I can conclude that the author's first hypothesis to explain his empirical findings ("The prevalent hypothesis that short-sales constraints lead to overvaluation does not hold in Hong Kong") is very much more likely than the second ("The applicability of this and other studies used to measure the effects of those constraints need to be re-examined.")

    Why? The overwhelming body of literature, spanning multiple world markets, supports the idea that short-sales constraints lead to overvaluation. In addition, Hong Kong presents some characteristics that are highly unusual in a sophisticated market/ economy (their Currency Board, to name but one).

    Alex Dumortier (XMFMarathonMan)

  • Report this Comment On September 23, 2008, at 8:50 AM, TMFAleph1 wrote:

    carstenjansing,

    I hadn't noticed that you had ended the "paper wielding" comment with a smiley; please don't take offense to the stern tone of my original reply.

    Alex Dumortier (XMFMarathonMan)

  • Report this Comment On September 23, 2008, at 12:01 PM, StructuralDefect wrote:

    Thank you for this article. So many people let their emotions, fear and misunderstanding fuel a hatred of short-sellers. If you try to tie the hands of short-sellers behind their backs with over-regulation, then who can offset the speculative short-term buyers who are not restricted by any targeted regulation? Not all buyers are the noble long-term buy-and-holders that populate our Foolish domain. And how many Fools can honestly say that they sell into a strong rally the instant they detect an "over-priced" stock or market? Long-term "legitimate" buyers and "legitimate" sellers can find balance. "Speculative" buying can be destructive to wealth, stability and pricing efficiency, if not balanced by "speculative" selling. In addition to being a long-term buy-and-holding Fool, I am also a very active trader who capitalizes daily and consistently on market inefficiencies (structural defects). Most of the market inefficiencies I profit from daily were CREATED by well-intentioned regulations. The LSE is one of the oldest stock markets in the world, and it has no uptick rule, no ETB list, less regulations restricting short-selling, and I have a very difficult time finding consistent trading profits on that market because of its intraday pricing efficiency. Investors should WANT to see a realistic, efficient pricing (even if its ugly) rather than a beautiful deception (prices propped up artificially by disrupting the balancing forces of short-selling).

  • Report this Comment On September 23, 2008, at 12:21 PM, TMFAleph1 wrote:

    StructuralDefect,

    Thanks for your comment -- it's interesting to get your perspective on the difference between the LSE and U.S. markets.

    Alex Dumortier (XMFMarathonMan)

  • Report this Comment On September 23, 2008, at 8:36 PM, RRGY2K wrote:

    XMFMarathonMan,

    Please help me out here: If I own a share that I keep in a brokerage account, and they let someone else borrow it to short it, the short sale of that same share to someone else causes us both to own the same share, right?

    Thanks for taking the time to discuss this with us.

  • Report this Comment On September 24, 2008, at 8:09 AM, carstenjansing wrote:

    The economic problem i see in short selling is, that a herd-phenomena of the public can ruin companies out of just fear and emotion.

    We all know that bubbles are created on the upside, due to speculative behaviour. There is no direct harm in that, just some unpleasent poof than the bubble pops/(just not the point here to discuss, there are negative effects, but not as harsh as on the other side.... )

    But what happens if the same phenoma happens to the downside? Excessive speculation on the short side, creating the same bubble.

    Maybe first time in history we witnessed that phenoma right here before our eyes, as short selling for the masses has finally arrived via Internet and online-brokerage.

    Real economic damage is done, as we witness atm. And that also could turn into a short-bubble that destroys the whole economy next time, not "only" Wall Street as it was this time around.

    Just to make sure, the short sellers are not the root of Wall Street problems, but they have speculated and deepend the crisis.

    So i say, before speculation destroys our whole economy next time, we better do stop that!

  • Report this Comment On September 24, 2008, at 9:33 AM, RRGY2K wrote:

    Structural Defect,

    "'Speculative' buying can be destructive to wealth, stability and pricing efficiency, if not balanced by "speculative" selling."

    Speculative buying is done by people who become shareholders, and might cause a stock to be overvalued. And those buyers can become sellers any time they want, with no net harm to anyone.

    And, it's literally their business, not yours. Speculative selling of short shares is done by people who are not shareholders and have no investment of any kind in the company. A share that doesn't exist ("borrowed" from a share owner who still owns it) is sold to a new buyer who is none the wiser. This is an artificial increase in supply which causes the market price to fall, precisely the intention of the short seller. People selling shares that don't really exist destroy wealth that rightfully belongs to the shareholder. The underlying company is a victim as well because of the impact on it's ability to raise additional capital.

    Traders think they are just harmlessly surfing on trends, without realizing or caring that collectively they are also creating the trends they are riding. Large interests have the power to control the market for small issues. I realize that shorting is immensely profitable for brokerages and that there are people who might have to get honest work if they couldn't short stocks to manipulate their prices anymore.

    Traders play with the price and move on. But the purpose of stock is to fund the development of businesses. Capital is the critical resource needed to fund new technologies and build businesses that produce new jobs and products. Short attacks can strip capital from a small company in a few days, substantially shorter than the years it takes to develop the new product that investors wanted to get in on.

    Short selling offers no economic benefit to anyone other than the people involved in the process. The business failures caused by short sighted short selling denies us jobs, tax revenues, and probably effective new cancer drugs too.

  • Report this Comment On September 24, 2008, at 12:06 PM, TMFAleph1 wrote:

    RRGY2K,

    Let me address your earlier question on why a short sale doesn't create two owners for the shares.

    The investor who lends out his/ her shares will retain the cash flow profile of a shareholder -- i.e. he/ she will receive cash amounts corresponding to all dividends and distributions made by the company during the term of the loan -- however, these cash payments are paid by the short seller, not by the company.

    More importantly, the investor who lends out his/ her shares is no longer the shareholder of record and, consequently has no voting rights. If he/ she wishes to exercise his/ her voting rights, he must call back the shares that he/ she lent out.

    If you wish to find out more about the mechanics of the stock loan market, I highly recommend the following two papers:

    'The Market for Borrowing Stock', Gene D'Avolio, http://jfe.rochester.edu/02105.pdf

    'Stocks Are Special Too: An Analysis of the Equity Lending Market', Geczy, Musto & Reed, http://jfe.rochester.edu/01472.pdf

    On your most recent post that "short-sighted" short sellers (not sure how you define those) are responsible for job losses, lost tax revenues and prevent the development of new cancer drugs: you forgot to add Kennedy's assassination to your list. I apologize for having to put this so bluntly, but your portrayal is inflammatory nonsense.

    Alex Dumortier (XMFMarathonMan)

  • Report this Comment On September 24, 2008, at 1:32 PM, RRGY2K wrote:

    Shares are lent by the brokerage, a privilege given them in the fine print as a condition of having a margin account. No one tells the account holder if any or all of his shares have been lent to shorts, and no payment to the owner of the shares is made if any shares are lent for shorting. The proxy statements keep coming to both owners and presumably it's up to the brokerage who lent the shares to deal with conflicts if they arise. There are supposedly ways to keep this from happening, for example by placing a sell order or moving the shares out of a margin account.

    Good stats are impossible to come by. While shares traded are reported every day, shares shorted are reported only once per month.

    I apologize for having to put this so bluntly, but there are companies that have been put out of business by short attacks. Shorting is not victimless. I am not aware of a connection to the Kennedy assassination, an assertion which is, of course, inflammatory nonsense on your part.

  • Report this Comment On September 24, 2008, at 3:52 PM, RRGY2K wrote:

    Alex,

    Thanks for sharing 94 pages of stuff about the share lending market and the shorting strategies of 2002. Now having read these papers, I can tell you that the bottom line is still this: Shares are artificially created in the market for the duration of the time they are sold and remain loaned, and companies and their stockholders are hurt by short sales of their shares.

  • Report this Comment On September 24, 2008, at 4:53 PM, TMFAleph1 wrote:

    RRGY2K,

    I shouldn't have made that "Kennedy assassination" quip, as it didn't contribute to keeping the discussion serious and cordial. For that, I apologize.

    I'm pleased that you took the time to read the papers I referenced. However, having read them, arguing that shares are artificially created during a short sale shows a willful disregard for established fact.

    As I hope I made clear in my article, I oppose abusive naked short selling. Abusive naked short selling is a perversion of the short selling mechanism. The overwhelming bulk of empirical evidence shows that the latter has a positive impact in well-functioning market (in terms of price discovery, for example).

    As far as "hurting" companies and shareholders, such loaded language is much too imprecise in this context for me to offer any comment thereon.

    Alex Dumortier (XMFMarathonMan)

  • Report this Comment On September 24, 2008, at 8:02 PM, RRGY2K wrote:

    Alex,

    We agree that naked short selling is abusive, and I presume that we agree that there has been a lot of it until very, very recently.

    Re: Shares artificially created

    You probably have a margin account, and the fine print probably reads like mine, which gives the brokerage the right to loan my shares for shorting without telling me. No problem, they tell me, I’m still a shareholder in every way, so I don’t really need to know (I'm told that the only way to avoid this is to put sell orders in place or take the shares out of the account).

    There’s no effect from loaning a share to somebody. But the instant the share is sold on the market I’m still here, but there’s also a new owner. Two of us owning the same share, in effect creates a new share. Unlike me, institutional holders consciously give up the voting rights and get paid for the privilege of lending the share, but their portfolio still shows a long position as well as the new buyer who is a new owner for the same share.

    Quoting from your referenced “The Market for Borrowing Stock” page 2 “Introduction”:

    “In essence, this short selling represents the creation of new supply that arbitrageurs might bring to bear on exuberant but downward sloping demand.”

    Price is defined by the point where the supply and demand curves intersect. The whole point of shorting is that “creation of new supply” necessarily contributes to the lowered price a short needs to show a profit. In the process, money is being taken by external people who don’t actually own any stock. External parties making money by messing with the price via the supply curve is a market manipulation that should always be illegal, just like other market manipulations. Lowered prices hurt stockholders right in the assets, and companies are hurt as they need capital. Am I being precise enough with my loaded language?

    Re: the overwhelming bulk of empirical evidence

    I would suppose that we further agree that short sales are very hard to discuss in detail since the data is not reported to investors or the public on 29 of the 30 days in each month. And I would suppose you would also agree that a free market in a free country would want to be disclosing any hidden vested interests in a stock on each of the other trading days as well.

    In this dearth of data and the 2 papers you referenced, I’ve obviously missed this overwhelming bulk of evidence, particularly as it regards small cap companies who are trying to develop new products. Instead, the overwhelming empirical evidence I see is is that short sales are being used to suck share value out companies with that new supply they bring to bear.

    Speaking of Bear, what do you suppose the short position was doing in their final days?

  • Report this Comment On September 26, 2008, at 3:17 PM, spongeworthyusa wrote:

    There's not a thing wrong with short selling, naked or clothed, if the target is well-managed and the books are right.

    Enron and Worldcom might still be cooking their books if a few canny shorters hadn't taken them on. Who thinks that would have been a good thing?

    The SEC's rule changes governing this activity were merely laughably too little too late fig leaves to cover shameful inaction by Treasury and the Fed in the face of much bigger problems in the financial industry.

  • Report this Comment On September 27, 2008, at 8:19 AM, RRGY2K wrote:

    The problem with Enron and Worldcom is that regardless of whether their books were cooked or not, if you weren't a shareholder these companies were literally not your business. They were owned by their stockholders, many of whom were also employees.

    Shorting created the panic, fed the fire, and made the fall into a crash, as shorters ripped through the market cap in a small number of days. If "canny" shorters weren't piling on companies when they hit difficult times, some businesses might be able to hang on long enough to find a way to survive, continue to pay their employees, and fund their pension plans instead of dumping the wreckage on the local economy and the taxpayers.

    There's nothing wrong with taking money from somebody in trouble as long as it's legal, right? I thought you'd say so, and that's why shorting somebody else's shares needs to be illegal.

  • Report this Comment On September 29, 2008, at 1:21 PM, UncleSkell wrote:

    I can't help but offer the observation that, if the naked short sellers hadn't sold their shorts, they probably wouldn't be naked.

    Just a thought...

  • Report this Comment On February 22, 2009, at 1:52 AM, frankiwa wrote:

    The author seems to be a bit misinformed when he says this:

    ""Myth No. 2: All naked short selling is illegal

    This myth is unfortunately widespread, but it's simply false.""

    ALL NAKED SHORT SELLING IS ILLEGAL, yet it still goes on. Just look at the reg sho. list that is publicly viewable for verification. The SEC is doing as little as possible to stop it.

    You can NOT differentiate naked short selling from abusive naked short selling. All naked short selling is abusive. You have to borrow the shares first and deliver them at settlement or it is considered naked short selling.

    Short selling is perfectly fine. However, naked short selling is a crime that continues everyday on a massive scale. Why would the investment bankers/brokers want to stop it when they get large lending fees from doing it?

    Think about it for a second. If you can sell as many shares of a company in the open market as you want without having to borrow it from someone, then you will overwhelm the supply of stock with sell orders. You can do this till the stock is near worthless, causing a panic, and the true long holders of the stock into a panic sell, effectively destroying the company, scaring their creditors, etc.

    Many companies are killed each week using this method by these unregulated hedge funds, and little can be done to stop them. There are more lawsuits against the hedge funds by victims of this crime then i care to mention.

    The common defense it is okay to sell a company short, it's not illegal. The victims always agree and say but you NAKED SHORT SOLD the stock, overwhelming the market with phantom sell orders.

    It seems few understand the difference b/t short selling and naked short selling and the simple legalities involved. Their aren't multiple kinds of naked short selling, (some abusive and some not). There is only short selling and naked short selling. And the latter is ILLEGAL.

  • Report this Comment On March 31, 2009, at 8:47 AM, thebyrdshouse wrote:

    I don't trade stocks, but do commodities futures, futures options, and forex. Just sharing some thoughts and agreeing with the big picture.

    Significant buying (going long) can create artificial highs just as significant selling (going short) can create artificial lows. This occurs naked and clothed.

    When speculating short-term, interest in a product or company of the underlying trade is oftimes irrelevant. Price movement and profiting from that movement is usually the goal. That's why a lot people get into trading. Everybody has different goals, though.

    Shorting what you own covers you 100%, but can still create downward price pressure. Naked shorting is a lot more risky (margin requirements as well as finding the stock/product in the marketplace). Small orders usually work fine, but the large ones, i.e.: abusive shorting, can cause havoc in any market.

    Lastly: anyone deal with options? If a naked option - call or put - is sold, you as a seller are obligated (if so exercised by buyer) to either sell or buy something you don't have. So, a naked call option is kind of like naked "longing". With a call, you sell someone the right to buy the underlying at a higher price than market, but they hope market moves above their strike price. Technically, you would be selling what you do not have, but at a HIGHER price. Naked, you would now have to go buy the underlying at market and give it to them, taking a loss (difference from strike). You sold low, having to cover the exercise by buying high and giving it to your option buyer.

    Interesting...

    p.s.: hopefully you sold that for an excellent premium!

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Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 733493, ~/Articles/ArticleHandler.aspx, 10/21/2014 6:35:51 AM

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