Learn about short selling - is it bad?

Learn about short selling - is it bad? I think we know enough about shorting now that we can start thinking about whether it’s a good or bad thing to have in financial market. So what I’ve done here is I’ve draw a hypothetical stock chart for company. This is time right here. This is the price of the company and let just say that this is a chart in the whole universe that doesn’t have short salaries in it. So, this is all you know. Here a lot of people are buying the stock and over here some people they maybe freak out or whatever. They start selling and then more people buy. So you know demands of little higher than supply, so there’s you know the price goes up and you know that just generally drives —. Now the short selling world, what would happen? Let’s think about two scenarios; a short seller who makes money and a short seller who loses money. So, short seller making money. What is short seller making money have to do if this is the stock? Obviously they don’t see the stock for beyond the data. They're actually making the trade but in order to make money, they’ll actually—they have to short at the local peak. So they would have to cover their short at the local minimum. So good shorts or you can even say a perfect short seller would maybe short here. Let me make it a different color, so you can see where his acting. With short here and then cover there, right and would make that much money on that move. And then you would weigh a little bit, wait for the stock to get expensive again in his mind and he would short here and then he would cover here. So this would kind of be obviously— very unlikely that someone could be so well picked top and bottles but let say there are really good at their analyzes and figuring it out market psychology and things like that, and they would just keep doing it. They will short here and cover here. What would that actually do to the stock? Right, the green line was a reality where you had no short sellers. Now if you all of a sudden you allowed short selling and they had these guys coming to the market who know how to make money shorting. He’s shorting up here, so what would short do? Shorting is you’re borrowing the stock and selling it. So he’s creating extra supply for the stock right. So what he would be doing at this point by shorting is he would actually be lowering the price at this point. So let me draw the curve, so if there’s a bunch of short sellers acting in this range. It would actually lower the peak because you have a bunch. You have some more aggregate sellers, right. So the price wouldn’t go as high and on the other hand. These short sellers have to cover right here, right. Their going to cover their position, so at the low point you have more aggregate buyers, covering a short position is just your buying the stock to pay it back because you borrowed it earlier. So here you would have more aggregate buyers and then at this point once again you have more aggregate sellers. So the price won’t go as high. You have more aggregate buyers here because the short sellers need a cover. So the price won’t go as low and so forth and so on. And the bottom line is a short seller, a short seller who is making money on the stock market. So their shorting the stock at peaks and covering the stock at— is actually reducing the volatility of the stock and that’s good foe everybody that’s good for the company’s management, that’s good for the actual shareholders of the company. And obviously, it’s good for the short sellers because they are, there are actually making money and this is actually true for anyone making money in the stock market that their reducing volatility. What is the along just a regular investor or I can call them a trader since they're buying and selling? A regular trader would make money by buying here, and selling here, buying here and selling here. So, really a regular trader is not any different. A regular long trader is no different than a short seller is just the order in which their buying or selling but anyone making money is buying at low points and selling at high points. And anyone doing that is helping to reduce the volatility in the stock and even if you’re long term buy and hold player. You would rather sit and hold a stock. Oh my computer is doing weird things. You would rather be a holder of a stock that does this than a holder of a stock that does this. Now there are a lot of players both on you know, you call them traders because their buying and selling on a regular basis that aren’t kind of doing this right. Maybe, their piling on the short set at low point and their causing the stock to go down even more, and then when the stock starts to move up. They get scared and they buy and it causes the stock to move to up even more and it increases the volatility of the stock but these guys are being penalize because their loosing money. The people who sell at low points and then buy at high points and increase the volatility, they're getting killed. Their falling everyday, so it’s not like you have to create some penalty for those guys. Their penalty is that there just bad traders. Their bad investors and their just going to loose their shares, so if you’re assuming that none of these traders and anyway manipulating the markets or spreading false rumors. Anyone making market, anyone making money on a stock as long their manipulating it on either the short or the long side is actually net asset for the stocks that their actually reducing the volatility of the stock price. And I guess another thing to think about and this is just from a, you know, it’s good their reducing the volatility, so from that point shorting doesn’t seem too bad for me or in general to the market. But another way to think about it is kind of where all the incentives in the markets right? Who has an incentive to be positive on a stock? And who has an incentive to be a negative on the stock where it scrutinizes? All right there you go. Well you know the biggest I guess cheerleaders for a stock and it depends on their degree of kind of credibility or ethics would be the company’s management right. These are people, oops my pen. Let me undo that and become company’s management. These are people who obviously run the company but they have the best transparency into the financials of a company and they tend to be shareholders of the company or get compensated base on how the stock does. So these guys have every incentive to be positive and as we seen multiple examples of whether you like talking about the investment banks or Enron or Accenture, they’ll often kind of hide the truth when things get bad. So, these guys are definitely, I mean big time positive on stocks and then let see, who are the other players or the influentors in financial markets? Well a big one is the financial press and I'll write it out here. So we can have a discussion about whether they are pampers of stock or whether they tend to be more, whether they to tend to scrutinizes things a little bit more. And the important thing to think about what the financial press and next time you watch CNBC and I don’t want to just pick on them is you know— how do they make money, right? Do they make money by finding things at a wrong with companies? Do they make money by making new money? Oh they make money by selling ads. They make money by selling ads and then the next question obviously is where they selling ads for mops or they're selling ads for bicycles? No, they're selling ads to financial services companies, to financial services companies. Financial services, so people who want to manage their wealth, stock brokers, and mutual fund companies, anyone who can advertise. And this is key two because I don’t know, you’re probably not aware of it but hedge funds can’t advertise. So, they're not consumers of the financial or their not customers of the financial press. The only people who are customers of the financial press are money managers, you know financial planners and things like that, brokers, mutual funds and all of these guys benefit when stock markets go up. Obviously seem mutual fund managers will; you know they tend to be long only, so they only want things to go up. Stock brokers, you might say, oh you know stock broker can advice you to go long or shorter and they just care about how many transactions you make but in general more and more people put money into the stock market in riding markets and a market like you’re seeing right now over the last year. People are pulling out, you know could say all maybe people are doing more transactions but the general matter of fact is people are pulling money out of the markets. So when they're pulling money out of the markets, you know brokers are getting less transaction. Their managing about less money and that’s also drove the money managers. And there’s also just— you know another ancillary side effect is when markets go down and people become less excited about the stock market. People stop watching CNBC and you know CNNFN. And so even those few ads that are for maps and for bicycles and for cars, they will get fewer viewers. So in general, the financial press at least in my opinion is squarely in this camp. Financial press and then we could talk more, you know cell side analyst. You probably heard the term cell side and by side but cell side analyzes are the analyze that work for the major broker — and investment banks who published those reports that you see in those ratings or by rating on IBM or whatever. And the reason why they call themselves side analyst is because they work for the people who are essentially on some level selling. You could either view them as their often offer securities or their offer financial services to often the companies themselves or to potential acquires of the companies or their selling their services. I mean usually their brokers services, so their trying to get people to transact. They’re actually brokers on some level but clearly these guys, their incentives are their customer tends to be the management of companies is to be very, very, very positive. And they used to say, oh well there are other people who are their whole job is to scrutinize these people like the government but if you think about once again. The government likes arising stock market. It takes you know when people 41K’s are rising. You know the economy does better. The government doesn’t have to worry as much about other types of social benefits and another plenty of things like that. So in general and end if you want to be more I guess, if you want to be more critical of the government. You could say that their, to some degree their very close to the income management of this firms and to financial companies and to some degree. These guys have significant cloud in terms of lobbyist and well actually I would even say the bankers too. The significant cloud in terms of lobbying and just an access to government generally and you know government drives the regulators, so these guys are also in the positive camp. And then finally have the ratings agencies and the rating agencies mainly operate in the depth world, and will talk more about that but if you can scrutinize a company on the depth level and you say, oh wow you know this company really isn’t that good or not going to be able to pay off its debt that kills the stock, right. But once again you have to realize that the rating agencies are also paid by the bankers, so the rating agencies are also have the incentive to kind of not see things when things are bad. So out of everyone in the financial services or the financial world that we’ve talked about right now, they all benefit when stocks continue to go up even when they go up beyond what they really should go up and even if they all kind of know that things are little bit too expensive or this management team might a little shady or they might be covering up something. None of these people really have an incentive to expose it and the only people who do are the short sellers. These are the only people who really have, well you know arguably sophistication and the time, and the monitory incentive to really look and scrutinize what management is doing. To really look in the books and kind of put a pop; you know put a puzzle together or put a bunch of pieces together. To come to conclusion weight, you know the numbers, the management is pouting really don’t add up and because of X, Y and Z. this company really is over valued. So to enlarge degree, they are kind of on society side in preventing management from kind of being overly bullish. And I know I don’t want to sound like someone who just broadly is defending short sellers. There is a class of short sellers that I think would be bad and that’s the people who are spreading false rumors and being market manipulators. So there’s this, the general you know market manipulation or you know rumor mongering, and that definitely is bad and to some degree if you can show someone is doing that. Then there should be some type of penalty for doing it. But even there you know just in my experience participating in public markets, if I have to pick you know, if I have to pick between the left side of that chart between this side of this side and this side of this chart. And if I have to say who does spread false information when it does gets spread. I think often times management is a little bit guiltier of it than the short sellers. In fact there are very few times that I’ve see where the short sellers are you know their some negative thesis on the stock and where it really comes out to be completely untrue. Although you know, there are examples and those short sellers you know I don’t think are really in the —. Anyway, I don’t want to meander too much. I realized that this video has already gotten long but I thought it is a nice useful discussion to maybe think a little bit about whether short selling really is all that bad even if you are a long investor.