Home > O risk! (and taking it in the shorts)

O risk! (and taking it in the shorts)

September 21st, 2008 at 04:35 am

So part of the grand plan is to temporarily stop the short selling of 799 stocks. And actually its not just the US that is regulating it; several other European exchanges have also temporarily stopped it, while China doesn't allow it in the first place.

Probably that alone caused my financial stock to nearly double from its low last month (11.10$ low/ 29.50$ yesterday).

Shorting a stock is reversing the order buying, owning and selling a stock. When you are long, you try to buy shares for a low price, hold it for a bit, then sell for a higher price. When you are short, you borrow the shares from a broker at a higher price, then arrange a time for when you will actually buy and deliver the stock. You hope that the stock will be lower by the time you have to buy it.

Shorting is useful - the main use is to add liquidity. Short sellers, like long sellers, actually have to buy the stock (at the end, not at the beginning), which means more buyers. Liquidity is a fancy way of describing that with those extra buyers stocks get traded more often and at more price points.

Another use is that short sellers are good markers for risk. Short selling is much more risky. A stock can only go down to zero, but can theoretically go up to any price. And if the stock goes up (to any price), the short seller has to buy it, losing much, much moolah. Stocks that attract short sellers should tip everybody off that something risky is happening.

Without the short sellers and only the long sellers, stocks of course can rise higher - only the optimists are allowed to trade. But what if the risks aren't quite as well defined and there are no optimists to be had? Stocks then drop in a much more sickening fashion - you can find an optimist if the price is low enough. Without liquidity, sometimes it has to be very, very low.

We'll see over the next few weeks what happens. Offhand it sounds like the "cure" is worse than the disease.

1 Responses to “O risk! (and taking it in the shorts)”

  1. Broken Arrow Says:

    Er yeah, China is kind of scary the amount of power they wield over their economy. However, I had to admit they are making good use of it so far to deflect damage and maintain their ideal growth rate (which I think is 10%).

    I've brought up option trading earlier, and especially in times like this, it really does give one perspective about the concept of "up to 100% gain, but unlimited loss". Even if it is a government ban that's causing it.

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