Betting on the stock market to go down is generally considered evil because you’re hoping for the average investor to lose money. Some investor activist groups actually want to ban the use of short selling in the stock market to protect long term investments while traders and institutional investment houses use it as part of their daily tools.
As we learn stock market history we find that the market moves in cycles. These cycles occur naturally in all kinds of economic measurements generally because of peoples’ behavior. When the market is in a very low point we appreciate investors rushing in to correct the bubble and return prices to reasonable levels. We try to take advantage of those lows ourselves if we have the money. Thus, the famous “Buy low, sell high” mantra of every new investor. However, the market needs the same correction when there is a bubble. We’ve felt the pains of bubbles popping from the dot com bubble of the late 1990’s that wiped out our retirement accounts, to the real estate bubble of this decade which has many of us tied up with too much mortgage and not enough house. When the prices get too high the average person who has no choice, but to accept what is available to him or her right now gets hurt. If instead we allow short selling the bubbles can be deflated earlier. People who recognize that the stock market is priced too high can “invest” against the market which will drive prices back down. This price check in the upward direction will keep the stock prices climbing at a steady, but realistic rate. Currently many retirement accounts don’t allow short selling so we are forced to buy stocks when they are at high prices or sit on cash. We need the professionals (and the market as a whole in my opinion) to keep these prices in line so you can have more confidence that the price you pay in your 401k is reasonable not 50% over priced.
The last huge advantage given to all of us by short sellers is market liquidity. When we want to buy shares in a stock we need someone sell them to us. Many people buy and hold their shares so their stocks just aren’t available on the market. Short selling “borrows” other peoples’ shares that they are holding and sells them with the contractual agreement to buy some shares back later to give back. This puts those idle shares back into the trading volume which means you’ll get to buy a stock at a price closer to the market price with less price jumping.
The financial markets depend on free trade. Short selling does not hinder your ability to purchase shares at a market value or sell them at a market value. While regulations are needed to ensure that the market isn’t being manipulated most of the manipulation doesn’t happen in the price of stocks, but in the marketing to average investors or the use of their investment money. Restricting pricing functions of the downside reduces downward price pressures creating unrealistic high returns which will eventually create a bigger crash on the last people holding the bag which is almost always those who don’t learn stock market techniques for themselves.
Workarounds have begun to find ways into the market. New trading instruments in the form of electronic traded funds have popped up which are a proxy for both shorting sectors and using leverage while only trading a standard equity. These are great for regular people to get access to these professional tools, however, untrained investors can be misguided by them or not fully understand their risks. If we opened up the standard tools for normal use with open education these proxies wouldn’t be required or regulated.
Related posts:
- How To Succeed In Short Term Investing
- Stock Market 101 – Part 2
- Shorting Stocks as an Investment Strategy
- Stock Market Trading Systems
- Stock market investment
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