0

The GME short squeeze was very interesting for me as a newbie trader because it had unexpected effects despite not holding that position:

  • some platforms forbid their user to buy some stocks or drastically limited the amount
  • eToro experienced a strange "bug" where GME and possibly other stocks had their Stop Loss set to an amount very close to the stock value, thus triggering the Stop Loss way sooner than expected (some compensation was provided for those traders)
  • some other stocks temporarily plummeted because the hedge funds had to sell big time to cover the losses incurred by the squeeze

I saw that many posted blamed the big shorting as immoral and creating a lot of problems in the market. I tried to find out more and reached this short article which explains why shorting is legal. If I understood correctly, shortly put: it used to be more regulated, now it does not seem to be that regulated and it is not clear what type of regulation would be effective.

From my rather obtuse perspective as a newbie long-term investor (I invest in something hoping to raise if it does the both me and the company win. Shorting seems like wining out of others' misery), I do not understand why shorting is not more regulated. What is exactly lost if it becomes more regulated? I see quite a lot of downsides of it being used (or abused).

1
  • Define "more regulated". The question would still be quite broad and not necessarily germane to the site, but regulations could take many forms, with various impacts from each. For example - are you asking about the impact of completely banning shorting? Or perhaps more strictly penalizing those who have naked shorts, or limit the total % value of a stock that could be shorted at any time, or taxed differently, orr.... Feb 3 at 19:41
1

Shorting seems like winning out of others' misery

Shorting is simply the opposite of buying, other than the quantitative risk (a short position has no upside loss limit). If you buy a stock and it drops, the short wins and you get the misery. If share price goes up, you win and the shorter gets the misery. There's nothing unfair about that.

If I understood correctly, shortly put: it used to be more regulated, now it does not seem to be that regulated and it is not clear what type of regulation would be effective. ... I do not understand why shorting is not more regulated.

You'll have to be more specific about what that is. Are you referring to the replacement of the Uptick Rule with the Alternate Uptick Rule?

I saw that many posted blamed the big shorting as immoral and creating a lot of problems in the market. I tried to find out more and reached this short article which explains why shorting is legal.

There are plenty of articles out there that explain the benefits or shorting. Many will agree with the concept, many will disagree.

some other stocks temporarily plummeted because the hedge funds had to sell big time to cover the losses incurred by the squeeze

Here's a loose construction from the other side. Suppose I'm a hedge fund investing in quality stocks on full 50% margin. IOW, I have $300 million and I buy $600 million worth of stocks. In bad judgement, I sink $200 million into stock XYZ because I think it's a sure winner.

It's March of a year ago and the market tanks 33%, taking me down to the long minimum margin requirement of 25%. Unfortunately, I'm also dead wrong about XYZ and it plummets a lot more than 33%. I get a margin call and I can't raise additional cash or provide additional marginable securities to meet the margin call. I close the short XYZ position but I also have to sell some other stocks in order to meet the margin call. Those other stocks temporarily plummet because of my attempt to survive (does that sound like Melvin Capital's actions?).

So what's the problem here? Instead of shorting, buying is a bad thing? Investing is a bad thing? Is it that being a hedge fund is a bad thing? Can I blame my problem on the CEO of XYZ. Can I blame panicked sellers for driving the market down 33%?

Some commonality in both scenarios is using margin, taking too large a position in one stock and bad judgement. I'm responsible for all of that and I got spanked for that.

Shorting isn't a bad thing, nor is investing. Abusing the position is.

6
  • 1
    Shorting seems inherently bad. It does not perform the role of the market - making capital available for publicly-traded companies to produce items of value to society. As the poster says, the money "earned" from a short comes from people who chose to buy at the wrong time. The short-seller makes money from others' misfortune, rather than a tide that raises all boats.
    – jdunlop
    Feb 3 at 19:47
  • Shorting is not the opposite of buying, because when you buy you can’t lose more than you invest. When you short, your losses are unlimited. Therefore, it is far riskier than buying, both for individuals and for the financial system.
    – Mike Scott
    Feb 3 at 19:47
  • @jdunlop - 1) The buying and selling of stocks does not make capital available for publicly-traded companies to produce items of value to society. 2) If you buy stock XYZ at $100 and it drops 10 points, you lose $10. If I short the stock at $100 and you buy it from me and it then drops $10, I make $10 and you still lose $10. I made $10 from my good judgement. I didn't steal anything from you. You lost money because of your bad judgement. Feb 3 at 19:57
  • @Mike Scott - Noted and amended. Feb 3 at 19:57
  • The entire point of stock offerings is to provide capital to a business. That the stocks subsequently trade hands is ancillary to that. The vagaries of the stock market make shorting less a case of "you made $10 from your good judgement" as "you bet that the next card was going to be black, I bet that it was going to be red". Either way, you're not making money from the creation of wealth, you're making money from my misfortune.
    – jdunlop
    Feb 3 at 20:02
-1

"The GME short squeeze was very interesting for me"

That is unfortunate, because there was utterly nothing, at all, interesting or unusual about it. Happens all the time and is of no consequence.

"I saw that many posted blamed the big shorting as immoral and creating a lot of problems in the market."

This is a good example of the utter, total, idiocy one often sees both online and on the news.

"I do not understand why shorting is not more regulated"

It is regulated.

Your observation is like saying "America has a good number of bridges. In my opinion we need to build a few more bridges though." Your friend comes along and says "Hmm, I disagree, we should be a little lighter on bridges."

Who cares?

It would be at best a detailed political debate.

It's inconceivable anyone can "answer" such a "question" because it's not a question. It is a vague general discussion.

Utterly nothing - nothing - happened. Nothing. Nada. Nil. Nothing. Nothing at all.

  1. Hedge funds are the "evil bad guys" of the corporate world. They put on billion dollar bets and either win or lose every week.

  2. They try to win a bit more often than they lose, they want to bat like "60%"

  3. They happened to lose this one.

  4. The hedge fund involved would have reached over, grabbed a few more nachos and prostitutes, and said "Bummer." And put on the next trade.

  5. Note too, that everyone hates hedge funds, they're the "evil bad guys". So, doubly, who cares?

The whole thing is a total non-issue.

1
  • Your observation is like saying "America has a good number of bridges. In my opinion we need to build a few more bridges though." Your friend comes along and says "Hmm, I disagree, we should be a little lighter on bridges." When is a bridge like a lot of Alaskan pork? Google "Bridge to Nowhere" Feb 3 at 20:30
-3

The Question is How

I am no financial whiz, but this is less a monetary consequences issue and more a legal one.

In its simplest form, shorting is borrowing property. (This is distinct from a "naked" short, but we'll just look at simple short selling.) People own shares of stocks. If you want to make short selling illegal (or heavily regulate it), shares become a class of possession with very special rules - you can't rent or loan them to others.

This is already tricky, but is complicated by the fact that big financial companies like short-selling as a financial tool. Making money without making anything has been a feature of the markets for more than a century at this point, so a law that removes anything that improves their ability to do so is something they will fight tooth and nail against.

So the financial consequences? It would probably be beneficial, as you say, to regulate or ban short-selling. But the legal and political consequences would mean that attempting to do so would result in sustained and aggressive lobbying against politicians suggesting it, and any laws would be tied up in court for years or decades by companies with pockets made deeper by successful short-selling.

3
  • 1
    Paragraph 1: sure. 2: sure. 3: sure. 4: a bunch of speculation there which removes any will to upvote the first 3 paragraphs.
    – user253751
    Feb 3 at 20:04
  • @user253751 - all the consequences of regulating short-selling are speculative. Your votes are your own, but how is political and legal speculation any different from economic speculation?
    – jdunlop
    Feb 3 at 20:07
  • Short sales improve market efficiency and facilitate price discovery. Feb 6 at 15:29

Not the answer you're looking for? Browse other questions tagged or ask your own question.