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Today, I've read a Bloomberg article on latest Musk tweet tantrums, where he, among other things, mentioned this:

Short-sellers are value destroyers. Should definitely be illegal.

Is that statement true? I've always thought, that short-sellers buying shares on days when stock is plummeting would actually slow the price fall.

  • In the long run, the only thing that matters is the earnings power of the company. In the short run stocks may be way overvalued, which is about the only time that being short makes much sense. Musk's issue is that Tesla isn't very profitable yet, but is valued at more than many large and profitable companies. – zeta-band Oct 5 '18 at 15:59
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Short sellers do not destroy value any more than stock buyers create it. Other than IPOs, buying and selling stocks is all done on the secondary market, so selling stock does not hurt a company any more than buying stock helps it.

I've always thought, that short-sellers buying shares on days when stock is plummeting would actually slow the price fall.

Except that short sellers don't buy shares, they borrow them to sell. How short selling works is you borrow shares from someone who already owns them, and sell them. You pay interest on the borrowed shares, and at some point you buy the shares back (hopefully at a lower price) and give them back to the person you borrowed from.

So there's no more price impact than normal buy and sell transactions.

The stigma with short sellers is that they are contrarian to the majority of investors who are "long" the market overall, so they are seen as friction. Also, in addition to their short selling they spread rumors to drive down the stock price, but this is also done on the buy side with "pump and dump" schemes, so again there's no more impact than what is done on the buy side.

  • It's possible that the OP was referring to short sellers buying to cover their short shares on down days and hence, that would "actually slow the price fall." – Bob Baerker Oct 5 '18 at 13:41
  • @BobBaerker OK I see that now. Still, there should be no more impact than someone else buying shares when they're down. – D Stanley Oct 5 '18 at 13:45
  • Buying is buying, regardless of whether the investor/trader is buying to open a long position or buying to close a short position. – Bob Baerker Oct 5 '18 at 13:52
  • @BobBaerker yes, that's what I meant – user2308001 Oct 5 '18 at 15:09
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D Stanley is correct that "Short sellers do not destroy value any more than stock buyers create it."

But just like stock buyers can cause a company to succeed, short sellers sometimes cause companies to fail.

Short sellers can prevent the company from selling stock to stock buyers. By lowering the market capitalization of a company, they can reduce a potential lender's valuation of the company. This can prevent loans and preferred stock issuances. It also harms the morale of employees who are emotionally attached to the value of their shares and/or stock options.

If the company's long-term prospects are dependent on short-term actions (such as issuances of securities, or short-term employee morale), then the actions of short sellers can severely harm the long-term value of the company. Of course, any company whose long-term prospects are that dependent on its short-term actions is very risky.

Also, large short-sellers tend to research companies to find out reasons other investors or speculators might want to avoid owning the companies' securities. Furthermore, they tend to aggressively promote any findings that tend to lower the stock price.

Even in bubbles, stock buyers tend to reduce their purchases of a stock if they perceive to the stock to be too pricy. Whereas short sellers (especially ones who doubt the viability of a company) sell increasing amounts of a stock as it goes down. Sometimes they are forced by "short squeezes" to buy back large amounts of stock all at once. So short sellers can increase the volatility of a stock's price. This can increase the public's perception of a stock's riskiness, and thus reduce demand for the stock in the short-term and intermediate-term.

  • How do short sellers lower the market capitalization of a company? – stannius Apr 24 at 16:36
  • @stannius -- In the immediate term, by selling stock. In the short term, by convincing other people to not buy the stock. – Jasper Apr 24 at 16:58
  • I think your answer could be improved by including that info. – stannius Apr 24 at 17:50
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Short selling helps the smooth market action by providing additional liquidity which in turn may narrow B/A spreads. It also provides information discovery which can uncover fraud (the classic example is Enron). In an honest market, this acts as a counter balance to 'irrational exuberance'.

Unfortunately, the players aren't always honest, whether they are pushing long 'pump and dump' schemes or on the short side, pushing 'short and distort' schemes or orchestrated bear raids, both of which can lead to panic selling. Hence the need for regulation of short selling (the uptick rule).

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Short sellers act as an anti-bubble force; without short sellers, the most someone can act on their belief that there is a bubble is selling shares they already own. If someone thinks there's a bubble, but they don't own any shares, then without short selling their opinion will not be reflected in the share price. Thus, short sellers can "bring forward" price drops: an anticipated future bursting of the bubble can cause a present-day price drop as short-sellers fulfill the extra demand created by the bubble. This just time-shifts the price drop, and, as you say, evens out on longer time horizons, as short-sellers buy to cover their positions.

And addressing Musk's tweet: the stock market is the aggregate opinion of everyone participating, weighted by how much wealth they have and are willing to risk. D Stanley alludes to this, but doesn't outright say it: there is a difference between value and price. Any time anyone submits a sell order to an exchange or fulfills a buy order, regardless of whether they're selling a stock they own, or a stock they've borrowed (short sale), they exert downwards pressure on the price. However, this doesn't affect the underlying value of the stock. If Musk truly means that value is destroyed, then he's just plain wrong. If he meant price, then not only is he using "value" when he means "price", but he's also saying that expressing a negative opinion of the company's value should be illegal.

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