In its simplest form, short selling involves taking a speculative position that a stock's price will fall; essentially it is the opposite of buying, or going long. Short selling, or shorting, also has psychological implications for the market whereby an elevated number of short positions introduces a negative market sentiment, thus driving down equity prices. Regulators can therefore attempt to curb these bearish forces before they spiral out of control. Such action was taken at the onset of the Great Recession, four days after collapse of Lehman Brothers. Similar measures are now being implemented in Europe, amidst the European debt crisis. (The media demonizes naked short selling, but in most cases it occurs in a collapse rather than causing it. Check out The Truth About Naked Short Selling.)

TUTORIAL: How To Use Short Selling

2008 and 2011
In 2008, the Securities and Exchange Commission (SEC) "took temporary emergency action to prohibit short selling in financial companies to protect the integrity and quality of the securities market and strengthen investor confidence." These measures were taken to prevent bearish speculators from gaining full control of the market, thus forcing unprecedented pullbacks in prices. Following the recent turmoil in Europe (and the Middle East and the United States and Africa) regulators in France, Belgium, Spain and Italy declared a 15-day ban on shorting banks and insurance companies. While not all members of the European Union support this new regulation, similar evidence of market abuse prevention is cited as the cause for the ban.

European Selloff
Politicians in Paris maintain their position that French debt is undoubtedly worthy of the AAA credit rating; Italian Prime Minister Silvio Berlusconi has upheld a similar belief, stating that the economic and financial position of Italy are "solid" and "investors' evaluations of our bonds don't take into proper account the solidity of our banking system." Investors, however, are ignoring these reassurances and have proceeded to sell their positions in Italian and French financial institutions. Prior to the ban on short selling, the iShares MSCI Europe Financials ETF lost nearly 30% of its value within the last few weeks, largely driven by short term speculative activity.

Temporary Protection
Shortly following the short selling ban, major French Banks BNP Paribas and Societe Generale spiked by 4.2% and 2.1% respectively while Italy's UniCredit jumped by over 5.5 percent, halting a steady downward trend. Unfortunately for France, Italy and other debt burdened European nations, short selling is a natural component of the financial markets that provides liquidity and a form of check-and balances to prevent prolonged periods of unstable hyper growth. After the 15-day period expires, the fundamental and psychological forces which normally drive the market will once again reemerge. After the 2008 ban on shorting, the Dow Jones Industrial Average continued to lose value until finally hitting its low on March 6, 2009.

Bottom Line
Although the initial response to the ban has been positive, a robust long-term action plan must be implemented in order to ensure that the debt problem will be properly managed. Ideally, this 15 day period will provide politicians more time so that they can figure out an alternative, whether it be comprehensive austerity or moderate budget reorganization before normal market activity is resumed. Enforcing a ban on short-selling does not remove the inherent risk present in Europe's financial sector. (This controversial strategy is blamed for making and breaking markets. Read Questioning The Virtue Of A Short Sale.)

Related Articles
  1. Chart Advisor

    ChartAdvisor for February 5, 2016

    Weekly technical summary of the major U.S. indexes.
  2. Stock Analysis

    6 Risks International Stocks Face in 2016

    Learn about risk factors that can influence your investment in foreign stocks and funds, and what regions are more at-risk than others.
  3. Investing News

    With Short Interest Surging, Is it Time to Buy?

    What do you think the smart money is doing when the market moves higher? Apparently, they're building short positions.
  4. Economics

    Lehman Brothers: The Largest Bankruptcy Filing Ever

    Lehman Brothers survived several crises, but the collapse of the U.S. housing market brought the company to its knees.
  5. Chart Advisor

    ChartAdvisor for January 29, 2016

    A weekly technical summary of the major U.S. indexes.
  6. Trading Strategies

    Why Is Short Selling Legal? A Brief History

    In the U.S., before a short sale can occur, broker/dealers must have reasonable grounds to believe that shares can be borrowed and delivered on time.
  7. Mutual Funds & ETFs

    The Long and Short of Trading Oil ETFs/ETNs (UWTI)

    Here are several oil ETFs to consider for both shorts and longs.
  8. Economics

    3 Economic Challenges France Faces in 2016

    Learn about the three most significant economic challenges facing France in 2016. How will France implement reforms to improve its GDP and reduce unemployment?
  9. Retirement

    3 Reasons Why This Is the Perfect Time To Visit Greece

    Discover three reasons why now is the best time to visit Greece, including the favorable exchange rate and the country's unrivaled hospitality.
  10. Chart Advisor

    ChartAdvisor for January, 22 2016

    A weekly technical summary of the major U.S. indexes.
RELATED FAQS
  1. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  2. How can an investor profit from a fall in the utilities sector?

    The utilities sector exhibits a high degree of stability compared to the broader market. This makes it best-suited for buy-and-hold ... Read Full Answer >>
  3. How can an investor profit from a decline in the real estate sector?

    Speculation enables investors to profit from a decline in the real estate sector. The most popular forms of speculation for ... Read Full Answer >>
  4. In what ways does Bayesian probability support the probability default model when ...

    During the European debt crisis, several countries in the Eurozone were faced with high structural deficits, a slowing economy ... Read Full Answer >>
  5. How can I evaluate if a stock is a short squeeze?

    To evaluate whether a stock is a short squeeze, traders should examine its fundamentals, short interest and price history. ... Read Full Answer >>
  6. What is the difference between a short squeeze and short covering?

    "Short covering" and "short squeeze" are different terms to describe a situation involving short positions. A short squeeze ... Read Full Answer >>
Hot Definitions
  1. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
  2. Ponzimonium

    After Bernard Madoff's $65 billion Ponzi scheme was revealed, many new (smaller-scale) Ponzi schemers became exposed. Ponzimonium ...
  3. Quarterly Earnings Report

    A quarterly filing made by public companies to report their performance. Included in earnings reports are items such as net ...
  4. Dark Pool Liquidity

    The trading volume created by institutional orders that are unavailable to the public. The bulk of dark pool liquidity is ...
  5. Godfather Offer

    An irrefutable takeover offer made to a target company by an acquiring company. Typically, the acquisition price's premium ...
Trading Center