Short Selling Banned

For years I have been in a twitch about the Short Selling of stocks. Shorting a stock is when you borrow shares of a stock from a broker in the hopes that it will go down. For example, GE is currently trading around $27 per share. Let's say you think the stock is overvalued and will go down so you decide to short the stock.

You log into your online brokerage account or call your broker and put in a short order for 1000 shares of GE Stock. The broker will then deposit $27,000 to your account. You basically borrowed the stock and sold it right away. But you are on the hook for $27,000 now.

Let's say 3 days later GE drops down to $25 per share. You buy 1000 shares for $25,000. You give those 1000 shares to the broker to cover your short. Thus your net profit is $2000.

When Short Selling stock, there has to be actual shares to cover the short sale. That is, a broker must agree to actually lend you the shares. Technically only as much stock exists as what can be shorted. Thus if Company B has 10,000,000 shares total it isn't possible for there to be short more than 15,000,000 shares.

But often times brokers play fast and loose with Short Selling rules and will do what is called Naked Shorting. That is, they will lend out the shares to people who want to short the stock even though there technically may be no shares left to lend. Technically this is illegal and for a long time Wall St. has denied and laughed at people who complained about Naked Short Selling.

Then last summer the SEC changed another rule called The Uptick Rule. It used to be you could not short a stock on a down tick of the price. This was put in place to prevent short sellers from piling on and driving down a stock price. Well last August the SEC suspended the Uptick Rule. Some, including myself thought this was wrong and that it would lead to Short Sellers piling on targeted stocks and driving down stock prices.

For years I have watched companies get raided by Short Sellers. Basically when a company's performance gets weak, if quarterly earnings are not exceeding expectations, a wave of Short Sellers will come in and start shorting the stock. Typically these are Hedge Funds. At the same time the hedge funds are shorting the stock they buy up the company bonds. Their goal is to drive the company into bankruptcy and receivership so that they can take over. Once they take over the company the stock is wiped out and new stock is issued to the new bondholders. It's happened time and time again to many companies over the years. Those who complain about it are painted as cookoo conspiracy theorists.

Well now that the short sellers have been piling on the financial sector stocks, Wall St.’s own life blood, they are not so happy about it. In fact, they are so upset about it they are banning Short Selling.

So much for the free market...Now, I would agree with this move in principle. However, I feel that Wall St should swallow the bitter tasting medicine. They scoffed and laughed at others who watched their portfolio get crushed by Short Sellers. They laughed when people complained about Naked Shorting or Short Sellers playing fast and loose with the rules.

Not so funny when it happens to them though...Now they know what it feels like.

The Dead Cat Bounce you are seeing the market the past two days or so-called "rallies" is hedge funds covering their shorts.

Regulators, industry giants seek to curb short selling

By Matt Andrejczak, MarketWatch

SAN FRANCISCO (MarketWatch) -- Gathering anger over short selling of vulnerable financial stocks exploded into the open Thursday as top market regulators and industry giants took steps to limit the practice and begin investigation into possible abuses.

Britain's stock market regulator on Thursday banned short selling in financial companies and said it might extend the ban to other sectors. The move followed the Securities and Exchange Commission's curbs on the practice that went into effect Thursday morning.

In other steps aimed squarely at the bearish practice, the country's largest pension fund, the California Public Employees' Retirement System, said it was taking steps to limit the practice on three financial stocks and the New York attorney general called for a wide-ranging investigation of the short selling of some prominent financial companies, including Goldman Sachs (GS:Goldman Sachs Group, Inc

The concerted reaction followed two days of sharp declines in global stock markets, triggered by mounting fears that the credit crunch would spin out of control and deepen the financial crisis. As stock declines have deepened, the role of short sellers has come under fire.

"The moves should help restrain the abusive short-selling practices lately rampant in the stock market," said analyst Thomas Brown of Bankstocks.com. "Short sellers can no longer deceive their brokers about their intention or ability to deliver shares." Article Continues Here

Cross Posted at Pissed On Politics