Is Short selling bad?

Over the previous decades there have been much criticism in the media over the subject of short selling. In my view most of these criticisms have come from ill educated sources who don’t really understand the mechanisms of the stock market.

 (Arden Forester)

Firstly, what is short selling and additionally what is this concept of ‘naked short selling’ that you might have heard about?

Short selling is an easy concept to grasp. You borrow a stock from either your broker or another customer and you sell it someone else. You are doing this because you anticipate the price will decrease and when you want to get out the position you buy it back. If the stock increases in value you loose money and vice-versa if it goes down you make money – simple!

Now naked short selling is the same concept except you don’t need to borrow the stock before making the trade. In essence you can short as much as you want. This is where problems can arise with abusive short selling as you can crash companies or currencies if you have enough money behind you and just keep pumping money into shorting. Hence this kind of abusive shorting has been banned in the USA since 2008.

(TheBigPicture.com)

I hear some criticism however which says, “you are short selling and driving the price of the stock down”. Another misconception in my view, first of all when you ‘short’ you affect the share price to an extent in a negative fashion downwards. But what most peope forget is that eventually you will have to get out of this position and buy it back, thus driving the price of the stock up when you exit! So the whole transaction has a zero sum effect. I agree ‘naked short’ selling is bad but normal ‘shorting’ has no negative impact upon the market. If anything it provides more liquidity – which is what all traders want. Thus shorting is ok!