April 11, 2009
I have been an active investor in financial markets since 1996. During that time, I have never engaged in short selling, although I do trade put options. My first comment on the subject is it's my view that short selling is one of the most risky trading strategies to which an investor may be exposed. The possible losses are potentially without limit, and the short seller can be forced to cover by the lender of the stock at any time. In general, traders who engage in short selling tend to be some of the most sophisticated and fundamentally well informed market participants. Short sellers are not attracted to fundamentally solid companies. As a general rule, short sellers engage in a highly methodical in depth analysis of a company, its financial condition and business prospects prior to placing a trade. They do not "drive the price down". They place trades in areas where market forces cannot support current values. It has become fashionable for CEOs, who have driven a company to the brink of bankruptcy through rank incompetence, to latch onto short sellers as a convenient scapegoat. A good example of this is Fannie Mae. It is a penny stock because it deserves to be a penny stock. You can find fundamentally more solid companies on the pink sheets. This is not the fault of short sellers.
It is worthy of note that the most dramatic drop in the Dow in recent memory occurred during the period last fall when short selling was banned. The reason for this should be obvious to any reasonably well informed market participant. When those holding long positions panic, and sell at whatever price they can, to salvage whatever they can, you have a backlog of short sellers buying the stock in order to book profits. The net effect of this short covering activity is price support under market conditions which would otherwise result in a full blown crash scenario.
We've seen this effect repeatedly since the short selling ban was removed. There have in fact been days when financial news of Depression era magnitude has actually caused market prices to go up. Personally, I am neither long nor short at this point in time. I do not trade in wildly unpredictable, fantastically volatile, irrational markets.
So, with the above as background, first and foremost, trading halts under any circumstances create market panic. Putting an up tick rule in place may sooth the ruffled feathers of the grossly misinformed, but as close as I could ever tell, up tick rules were unenforced and unenforcable even when they were in place. The current proposals amount to slapping a bandaid on a sucking chest wound. We are 9 months into the Second Great Depression and economic fundamentals are in free fall. Sooner or later market value will equal fundamental value. We are a VERY long way from the bottom.
Why not ban short selling altogether, let the markets crash, and let a few players make a ton of money on put options? I wouldn't play options in the current market, but I'd certainly take a look some possible trades if you put a stop to short players buying stock just when things start to get interesting.