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Pecuniary trailblazers are leading actors

 

Term Traders (TT) and Short Sellers (SS), are held responsible erroneously for manipulating stock prices, forcing them down far below their real value, and for creating crashes and chaos.

 

In fact, short sellers have been identified as so vile by SEC Chairman that he has banned short selling for 1000 publicly traded companies. Critics of the market blame short sellers for several grievances:

 

 - TT/SS destabilize prices in a shaky market, and in a panic can cause a crash.

 

 - TT/SS artificially engage in "bear raids," where traders gang up on an illiquid - or thinly held - publicly traded company and push the price way down below their intrinsic value. After the stock plunges, traders cover their shorts and buy up good companies at bargain prices.

 

By temporarily banning TT/SS, SEC Chairman hopes to prevent the stock market from declining further even if in so far doing so he has been unsuccessful.

 

So who is accurate, the TT/SS proponents, or SEC Chairman? The best way to determine the truth is to look at what TT/SS is, and the evidence on what it does exactly.

 

What exactly is TT/SS?

 

TT/SS is a way for investors to bet on falling prices, and for long-term investors to protect their investment portfolio during a bear market.

 

Most investors profit from stocks by buying a stock and then selling it when the price goes up. TT/SS do the opposite. They sell a stock first and then buy it back when the price goes down.

 

They accomplish this by borrowing the stock first and then selling it. To close their trade they purchase the shares, hopefully at a discount. When they buy the stock back, they return the borrowed stock to the owner and pocket the profit from the difference in price. TT/SS must take place in a margin account because the TT/SS are using borrowed money.

 

Naked short selling is much more controversial. It is defined as a short sale by power brokers and financial dealers, who sell short without borrowing it first. The SEC recently banned this practice as well unfortunately much to our dissatisfaction.

 

However, investors can also sell short stock that they own. This is the least controversial technique and it is often used at the end of the calendar year to lock in profits in a stock that has gone up in price.

 

But with the potential positive and negative aspects of TT/SS, what do the facts from the scientific community show?

 

On bear raids:

 

- In recent years, when academic researchers have looked for bear raids even in those areas in which investors suspected that they existed, they have not found them. They could not even find evidence of bear raids on beleaguered financial stocks. They conclude that TT/SS reacted to downward momentum, rather than caused it. Typically, TT/SS trade in response to past negative news, rather than inducing current stock price drops.

 

However, while bear raids are unlikely in mid to large companies because of their size, it is thought yet not believed nor accepted as a norm that TT/SS can artificially manipulate small cap and penny stocks.

 

On TT/SS causing greater volatility:

 

- It has been found just the opposite that stocks without short selling not infrequently trade at prices that deviate widely from their true value.

 

Benefits of Short Selling

 

Academic studies also show three major advantages of using TT/SS:

 

- Countering of the irrational exuberance that company officials and bullish promoters parade about their stocks, and encourage a more sensible valuation of a company's worth.

 

- TT/SS is a legitimate way to hedge your position. It is not simply a strategy to profit from falling prices. Major institutions and conservative investors often use TT/SS to lock in a position for a period of time, and protect themselves from downside risk.

 

- TT/SS provide extra liquidity and thus reduce bid asked spreads. It is TT/SS that allow long term investors to sell when they want to.

 

From a practical point of view, while short selling of individual stocks is temporarily prohibited, investors can still play the down side of the market by buying short exchange-traded funds (ETFs).

 

We are very much afraid that the ban on short selling may prolong the multitier and multilayer crisis on all societal levels in the sense that it will now take the markets longer to adjust to the true values of financial companies.

 

TT/SS are in fact helping the world make the markets more healthy, efficient and more profitable for investors. In today's market environment we can use as many of these TT/SS leading actors as we can get.

 

We would like to believe that the SEC Chairman reverses the ban on short selling, period.

 

The SEC decided to continue the short-selling ban after a bailout bill was passed. Central banks from Australia, Canada and the U.K. have instituted similar TT/SS bans in recent weeks {sec.gov/spotlight/keyregshoissue.html}.

 

Hedge funds and institutions are the largest users of TT/SS, and they have been among the most vocal opponents of the ban. They cite the increased volatility and negative market movement since the restrictions went into affect as reasons to repeal them.

 

It should be noted that TT/SS continues to be a strategy that should be used only by experienced investors. Unlike a simple stock purchase, the risks associated with shorting can lead to greater losses than the initial investment.

 

For example:

 

- Investors going long, buying and expecting the price to go up, have the potential for unlimited gains because there is no limit to where the stock's price could go. The maximum loss is only the amount of funds that corresponds to the initial investment.

 

- Investors who short a stock is in the exact opposite position. If the stock drops to zero, their maximum gain is fixed; it is the difference between the purchase price and zero. However, their maximum risk is unlimited, because their potential positive stock movement is infinite.