Importance of Short-selling in Markets-vrk100-20Mar2020
Short-sellers are vital cogs in the wheels of financial markets. They bring valuable insights into the markets. These insights mostly consist of weak fundamentals of a company or a security they are shorting.
Quite often, short-sellers are ahead of the game in identifying shady promoters, inept managements & lacunae in balance sheets. We should be grateful to short-sellers for bringing those insights to us. Unfortunately, they are the favourite whipping boys in the market place.
You may have observed this behaviour from promoters also. In fact, when a company is blaming short-sellers, it's a red flag against the company. Short-selling is a legitimate activity in financial markets.
Mind you, short sellers are the largest (panic) buyers when markets rebound--because they've to do short-covering in a big way. I think we need to give more respect to short-sellers, considering the advantages they bring to financial markets.
Promoters routinely blame short-sellers for the troubles the company is facing. Most of these promoters are in the habit of diverting attention of stakeholders, by pointing their fingers at short-sellers.
Most short-sellers are professionals. Short-selling is a key part of their investment strategy--most of these professionals employ long positions in coordination with short positions. I mean they're simultaneously long some securities and short other securities.
Jack Schwager's "Stock Market Wizards" is a fascinating book. Of the 15 traders he interviewed in the book, 14 of them employ short-selling into their overall strategy. One such interesting trader is Dana Galante, who has a compelling story to tell on short-selling.
But short-selling is a high risk strategy. And it's highly challenging and sophisticated. The profit is limited, while the losses are unlimited. Suppose you've shorted a stock quoting at $400. Your maximum profit is $400 only, for theoretically a stock can't go below zero.
On the other hand, after you shorted the stock at $400, it can theoretically go up to infinity in which case your losses will be astronomical. And you will be ruined completely and will never be able to make it again to markets.
So, short selling isn't suitable for neophyte traders. From a philosophical viewpoint, we're optimistic creatures. We hold securities in order to make profit when prices rise. If you believe in them rising ultimately over long periods, short-selling may not be profitable.
India's capital market regulator was mature enough not to ban short-selling during Lehman Brothers collapse in 2008/ 2009. Let's hope SEBI is wise and mature enough to take actions or inaction considering the best interests of market participants and market integrity.
Disclaimer: This is not a recommendation for short-selling. This is just my personal opinion. Disclosure: I've never done short-selling in my investing life. Enjoy and have a profitable decade ahead of you!
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The above opinion is from a tweet thread I made on Twitter @vrk100 on 20Mar2020.
Thread.
— RamaKrishna Vadlamudi, CFA (@vrk100) March 20, 2020
Short-sellers are vital cogs in the wheels of financial markets. They bring valuable insights into the markets. These insights mostly consist of weak fundamentals of a company or a security they are shorting. 1/12
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