Ethics And The Role Of Short Selling
  1. Short Selling Guide: Introduction
  2. What Is Short Selling?
  3. Example of a Short Selling Transaction
  4. Short Selling Strategies and Margin
  5. Timing a Short Sale
  6. Short Selling Analytics
  7. Short Selling Alternatives
  8. Risks of Short Selling
  9. Ethics And The Role Of Short Selling
  10. Short Selling Guide: Conclusion

Ethics And The Role Of Short Selling

It's safe to say that short sellers aren't the most popular people on Wall Street. Many investors see short selling as "un-American" and "betting against the home team" because these sellers are perceived to seek out troubled companies.

Some critics even believe that short sales are a major cause of market downturns, such as the crash in 1987. There isn't a whole lot of evidence to support this, as other factors such as derivatives and program trading also played a massive role, but two years after the crash, the U.S. government held the 1989 House subcommittee hearing on short selling. Lawmakers wanted to look at the effects short sellers had on small companies and examined the need for regulation after allegations of widespread manipulation by short sellers of over-the-counter stocks. SEC officials reassured the public that manipulations hadn't been uncovered and more rules would be put in place. (To learn more, read Questioning The Virtue Of A Short Sale and The Uptick Rule: Does It Keep Bear Markets Ticking?)

But despite its critics, it's tough to deny that short selling makes an important contribution to the market by:

  • Adding liquidity to share transactions. The additional buying and selling reduces the difference between the price at which shares can be bought and sold.
  • Driving down overpriced securities by lowering the cost to execute a trade
  • Increasing the overall efficiency of the markets by quickening price adjustments
  • Acting as the first line of defense against financial fraud. For instance, in 2001, famed short seller James Chanos identified fraudulent accounting practices that occurred with the Enron Corporation, an energy-trading and utilities company. The company's activity became known as the Enron scandal when the company was found to have inflated its revenues. It filed Chapter 11 bankruptcy at the end of 2001. (To learn more about this scandal, see The Biggest Stock Scams Of All Time.)

While the conflicts of interest from investment banking keep some analysts from giving completely unbiased research, work from short sellers is often regarded as being some of the most detailed and highest quality research in the market. It's been said that short sellers actually prevent crashes because they provide a voice of reason during raging bull markets.

However, short selling also has a dark side, courtesy of a small number of traders who are not above using unethical tactics to make a profit. Sometimes referred to as the "short and distort," this technique takes place when traders manipulate stock prices in a bear market by taking short positions and then using a smear campaign to drive down the target stocks. This is the mirror version of the pump and dump, where crooks buy stock (take a long position) and issue false information that causes the target stock's price to increase. Short selling abuse like this has grown along with internet trading and the growing trend of small investors and online trading. (For more insight, read The Short And Distort: Stock Manipulation In A Bear Market.)

Short Selling Guide: Conclusion

  1. Short Selling Guide: Introduction
  2. What Is Short Selling?
  3. Example of a Short Selling Transaction
  4. Short Selling Strategies and Margin
  5. Timing a Short Sale
  6. Short Selling Analytics
  7. Short Selling Alternatives
  8. Risks of Short Selling
  9. Ethics And The Role Of Short Selling
  10. Short Selling Guide: Conclusion
RELATED TERMS
  1. Short Selling

    Short selling is the sale of a security that is not owned by ...
  2. Short Covering

    Buying back borrowed securities in order to close an open short ...
  3. Bear Raid

    The illegal practice of ganging up to push a stock's price lower ...
  4. Weak Shorts

    Traders or investors who hold a short position in a stock or ...
  5. Short Squeeze

    A situation in which a heavily shorted stock or commodity moves ...
  6. Short Sale

    A market transaction in which an investor sells borrowed securities ...
RELATED FAQS
  1. Is short selling ethical?

    Understand the concept and practice of short selling, and examine the ethical questions that some investors raise in regard ... Read Answer >>
  2. How is it possible to trade on a stock you don't own, as is done in short selling?

    Understand how the process of short selling allows a person to sell a stock he or she doesn't technically own by borrowing ... Read Answer >>
  3. How does short selling help the market and investors?

    Find out how short sellers provide a service to the market by acting as a check against overvalued companies and exposing ... Read Answer >>
  4. Please explain what a short seller is on the hook for when he or she shorts a stock ...

    Short selling is hard enough to get your head around without getting into all the particulars. If you have a basic understanding ... Read Answer >>
  5. What is the difference between a short squeeze and short covering?

    Learn about short covering and short squeezes, the difference them and what causes short squeezes. Read Answer >>
  6. What is the difference between a short position and a short sale?

    Learn how short selling and short positioning are different, specifically in regards to the nature of the commodity being ... Read Answer >>

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