Short-selling has been much in the news lately and not only in Australia but also in the USA. According to Mr Andrew Forrest, “the activity is "almost criminal"”. Mr. Forrest, incidentally the richest man in Australia, has reason to proclaim the above since he saw its Iron ore miner Fortescue Metals Group Ltd fall by one third in market value in the last few weeks.
A large number of companies have complained recently that its shares have been shorted, much to their distress. And short-sellers have been slammed by not requesting permission to use their client's shares. Short-selling seems to have become now a trend helped by a falling equities market.
But what is short-selling, the reader might ask. Short-selling is as old as the market and involves one trader to use a number of a client's shares which he sells when its price falls. The trader then waits until the price has fallen substantially and covers the trade by buying the same company's shares back and giving then to the client. The difference in price is the trader's gain.
In an example, if a trader sells 100 shares ACH at $10 and then buys them back at $2 he makes a pre-tax gain of $800, ((100*10)-(100*2) = 800).
Originally, and still today, the client whose shares are used is not even told of the operation and he earns nothing from it. As it results clear, short-selling is a trader's illegitimate expedient and creates no value.
Together with shorting there's squeezing. When a shorting attack on a company is concerted, and there have been many recently, an initial fall in price will be magnified by the shorting since more stock is being sold into the market. This then causes a further fall in price on the shorted shares. In the end companies find themselves in pretty miserable situations sometimes.
To increase this effect rumours have been spread consistently prior to shorting a stock to incentive mum's and dad's and institutions as well to sell their shares. The whole thing stinks.
But what stinks the most is that short-selling is done with total disregard for the fundamentals of the companies in question, whether good or not. Often the concerted shorter selects and observes companies that are prone to some sort of problem. Recently, companies that had excessive levels of debt such as ABC Learning and Centro, Allco and Babcock and Brown were selected for shorting. As soon as the credit crunch came and their stocks suffered with it, shorting started.
We do not know who shorted these companies neither whose shares were used. It didn't matter for the shorter whether their business propositions were sound, whether their debt positions could be improved. On the other hand, by shorting these companies' price certain clauses in their debt agreements were activated much for their distress. Most of them had to make fire sales of assets to reduce debt and undergone considerable distress. But on the other end of town the shorter laughs.
Shorting, because it is based on selling a company's shares, is about exiting a business. One could ask whether an entity who abandons an investment should have the power to lastingly and negatively affect it for a long time and a string of consequences. You know, when you want to exit an investment you sell your shares and that's it. But the shorter destroys a company.
I considering that shorting has become herd mentality, and ultimately, if all companies were shorted simultaneously to their last consequences the entire market would be squeezed out of existence. While this is absurd as a proposition, I hope it shows to you, dear reader, that shorting is destructive in nature and immoral in method.
Indeed, I agree with Mr Forrest that shorting is criminal. I think it should be made so by law and jail penalties should be implemented for culprits.
