Short Selling Explained

WHAT IS SHORT SELLING?

Short selling in finance involves investing in a way that results in profit if the asset's value decreases, which is the opposite of a long position. Short positions can be achieved through selling borrowed assets or through derivatives like futures, forwards, options, or swaps. A short seller may need to pay a fee to borrow securities and may need to post margin as collateral to ensure that they can meet any liabilities. Short selling is a common practice in public securities, futures or currency markets that are fungible and reasonably liquid/ and may be used by speculators to profit from an overvalued instrument or by traders or fund managers to hedge certain risks in a portfolio. Banning short selling has been found to be ineffective and has negative effects on markets. However, short selling faces criticism and hostility from society and policymakers at times.

SHORT SELLING CONVICTION

Sometimes people borrow things called securities so they can sell them and make money if the price goes down. They have to give the securities back later, but they hope to buy them back for less money and keep the difference. This can work well, but it can also be risky because if the price goes up instead of down, they could lose a lot of money. People can also do similar things with other kinds of contracts to make money if the price of something goes down.

FORTUNES OF SHORT SELLING

Short selling was invented by Dutch businessman Isaac Le Maire in 1609, who was a significant shareholder of the Dutch East India Company. Short selling puts downward pressure on a stock's price, making it a target for criticism due to its complex tactics. Governments have restricted or banned short-selling at different times in history.

The collapse of the London banking house of Neal, James, Fordyce and Down in 1772 led to a major crisis that affected almost every private bank in Scotland and caused a liquidity crisis in London and Amsterdam. The bank had been speculating by shorting East India Company stock and using customer deposits to cover losses. Short selling was also used by George Soros in 1992 when he famously "broke the Bank of England" by selling short more than $10 billion worth of pounds sterling.

The term "short" has been in use since the mid-nineteenth century and is believed to be used because short sellers are in a deficit position with their brokerage house. Jacob Little began shorting stocks in the US in 1822 and was known as The Great Bear of Wall Street

Short sellers were held responsible for the Wall Street Crash of 1929, and regulations governing short selling were introduced in the United States in 1929 and 1940. The political consequences of the crash resulted in a law prohibiting short sellers from selling shares during a downtick. This uptick rule was enforced until 2007 when it was removed by the Securities and Exchange Commission. Short selling was condemned by President Herbert Hoover, and J. Edgar Hoover vowed to investigate short sellers' role in prolonging the Great Depression. In 1949, Alfred Winslow Jones created an unregulated fund that bought stocks while selling others short, creating the first hedge fund.

Negative news can attract professional traders to sell a stock short in anticipation of its price decreasing. However, during the dot-com bubble, shorting start-up companies could lead to losses if the company was acquired at a higher price than the short-sellers had anticipated, leading to forced position coverings and overpayment by the acquiring firm.