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Smart Investor Tip of the Day
Most investing practices consist of buying with the hope that the underlying security will rise which then can be sold for a profit. Another strategy works in the opposite direction. It is known as “shorting”, or short selling, of a security whereby the intent is to have the price fall so that later it can be purchased at a lower value.
Short selling has had a long and controversial past spanning back into the American stock crash of 1912. During the 2008 financial crisis several European countries banned the practice with the thinking that it was part of the reason for compounding declining values in stocks. Most companies don’t like short selling activity because it reduces the value of the underlying shares.
Short selling does provide a way for investors to profit on a company who is experiencing declining fortunes. However, the practice can be abused and even potentially illegal. Naked short selling is one of these illegal approaches. It involves an underlying broker. A broker must ensure there are available shares in a stock that can be borrowed and then shorted. However, there have been many cases where markets have been manipulated on “nakedly” shorting shares that weren’t available to be shorted. This would tend to drive share prices down.
When all is said and done short selling leaves a bad taste in most people’s mouths despite its advantages. Short selling gives investors and brokers the ability to hedge their bets in the event that a company underperforms. It’s this reason that short selling bans usually result in less efficient markets.