Thursday, 20 May 2010

On the insanity of banning short selling.

The Germans have mistaken "causing" for "profiting from". There is so much wrong with banning short selling that I don't know where to begin.

First, a little about short selling. It is the practice of selling stock you don't own (selling whilst "short" of the stock) in the hope of buying it back cheaper at some future point. You can either do this "Naked" without owning stock (this is not allowed on most stockmarkets) or you can borrow the stock from someone else for the purpose. On derivative markets you either go long or short depending on which side of the contract you're on.

Most trading strategies (I'll stick to equities, because that's what I know best) involving shorts are "pairs trades" or similar. That is you seek to exploit the difference between two similar, but not identical securities. You go Long (buy), for example Barclays and go Short (sell) RBS. By doing so you hope to profit from the fact that Barclays can still pay its traders enough to stick around, and RBS can't and therefore can't make money.

So... what happens when you ban short selling: all those people wisely hedging out market risk as in the above example are forced to buy the stock they consider crap, and sell the stock they consider good. By denying the prospect of hedging, the market's risk goes up, and the value falls. Basically if you think that banning short selling will prevent "speculators" from "driving the price down", whether it's currency derivatives or equity then you're demonstrating your profound ignorance.

If you're selling the socialist worker, that's fine. When you're running the third largest economy in the world, it's not so good.

So... the Box-heads have succeeded in giving me the buying opportunity I've been waiting for for months. Bravo. And it won't stop whatever it is - euro weakness, banks going bust you thought you were protecting yourself from. If anything, it creates an imbalance and will make likely anything you're trying to avoid.

Don't believe me? look at the charts for the banks around the dates of the 08/09 short selling ban.



3 comments:

Dusty Bin said...

Hang on.

I thought the ban was on naked shorts only (which is also proposed by the EP's version of the AIFM Directive)...?

Jackart said...

They've banned short selling on CDS and other instruments covering Eurosone debt. I think they have protecting the Euro in mind. It's facile, but for domestic consumption, and Merkel is facing electoral issues? But the Equity example is one I understand.

Idle Pen Pusher said...

Have I misread, Jackart, or did you neglect to mention that shorting has the effect of reducing price volatility (by allowing those who believe a price fall is imminent to sell an asset (and therefore exert downward pressure on the price) before that expected price drop actually happens)?

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