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Short Selling Ban Suggests Big Trouble Ahead

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Tuesday, 16 Aug 2011 07:21 AM Current | Bio | Archive

Stocks will likely decline over the next few months, thanks to several European countries that imposed bans on short selling last week. That’s because every instance of banning short selling has proven to be self-defeating.

But I’m getting ahead of myself. First, a quick refresher on what shorting is and why it’s important:

In and of itself, shorting is simply another tool for investors. When buying a stock, investors make the prediction that a company’s share price will go up.

The specific reason isn’t necessarily important. The company’s earnings may be increasing, it may have hidden assets, or it may be subject to being taken over by a bigger company.

When shorting a stock, investors are simply making the prediction that a company’s share price will decline. Of course, investors who short have to do their homework too. They have to look for a company with declining earnings, hidden liabilities, and potential legal or tax issues that could send shares spiraling. Usually, the specific reason for shorting is critically important.

In Europe, the bans that took effect last week are largely limited to large banking institutions. These banks have substantial exposure to toxic assets, including Greek, Spanish, Irish, and Portuguese bonds. As banks, they also have short-term debts out with other banks with similar exposure.

It’s not so different from the banking crisis that occurred with the American banking system in 2008. When short selling financial stocks was banned in the United States in 2008, they promptly fell 20 percent. That was after already falling an average of 25 percent.

The idea behind the short selling ban was that the price couldn’t be driven any lower by short-sellers. But with the ban in place, investors asked themselves one important question: Why would a sound company need a ban on shorting its shares?

The answer should be clear.

If anything, short selling bans are self-defeating. They send a signal to the market by regulators that all is not well. The fundamentals of a company don’t change because of a ban.

Allowing individuals to short stocks creates more market transparency, as it encourages more research into companies that could have trouble. It gives the market a better picture as to the overall strength of a company, rather than an opinion that’s biased towards optimism because a fund manager is long shares.

If anything, creating a market restriction like a short selling ban can only undermine confidence in markets. It sends investors the message that market regulations can come in any form at any time.

Even if you’d never short a stock if your financial life depended on it, keeping an eye on short sale bans can give valuable insight to the market’s direction over the next few months. For the moment, investors who are looking to buy may be able to get better bargains if they exercise patience and wait.

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AndrewPacker
Stocks will likely decline over the next few months, thanks to several European countries that imposed bans on short selling last week. That s because every instance of banning short selling has proven to be self-defeating. But I m getting ahead of myself. First, a quick...
Short,Selling,Ban,packer
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2011-21-16
Tuesday, 16 Aug 2011 07:21 AM
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