Ask HN: Serious question, why is short selling allowed? | Hacker News Reader

Ask HN: Serious question, why is short selling allowed?

6 pointstrestenhortz10 comments

I think we have to take the question and flip it, as the law (mostly) lays out what you can't do, rather than what you can. If I own X shares in company Y, why can't I enter in to a contract with you whereby you take my X shares and return them to me on date Z?

If I can do that, why can't you sell those shares and buy them back (presuming I'm okay with that)?

It is just sort of the default position, and stems more from our property rights than anything inherent in securities law.

Short selling is a really useful tool.

Say the price of potatoes is $100 per pound today, but my potatoes aren't ready until next week. Well, I can take out a short contract to lock in the price and when my potatoes are ready I sell the potatoes and close the short.

I'm covered in both cases. If the price goes down I will make profit on my short contract but less price on the potatoes. If the price goes up then my short will lose some value but the increase in my potatoes will cover the losses. In either case I will have gain the $100 I was expecting.

That’s an example where you (almost) have the underlying goods, and then, short selling indeed is a useful tool.

The problem is with naked short selling (https://en.wikipedia.org/wiki/Naked_short_selling), which doesn’t require you to have the potatoes at all. So, it takes less investment to do, but of course, if, next week you have to cough up the potatoes, and the prices did go up, your losses can be huge (basically, in the ‘covered’ version, most of your money is in the potatoes, not in the futures. With naked short selling, you can invest all your money in very volatile potato futures. That increases your risk)

That's the reason margin requirements exist. If the trade moves against you, there's an amount of money in your account that will be used to settle the transaction. If the trade moves too far against you, your broker will close the position for you at a loss.

To prevent the market from thinking that a company worth $0 is worth $4 billion

Heh. Thanks for the laugh.

the pleasure was all mine!

Short selling gives additional financial incentive to research companies and figure out which ones are full of it. That's useful to the market overall, not just to the short-sellers themselves.

I don’t have anything against shorting – still a very interesting question!

Look for wirecard

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