Today's guest blog entry comes from Scott Krady
Regulators and market experts will be paying close attention to the markets on Thursday as the temporary ban on the short selling of nearly 1000 companies is lifted. The SEC created the rule - a ban that began on September 22 temporarily halting the practice in which traders borrow shares and sell them in order to take profits. With a short sale, investors sell shares they do not own (essentially borrowing them) and later purchase them at a lower price, anticipating that during the sell/buy interval the price of the stock will drop. Key behind the SEC’s ban on short selling has been regulators’ concern over rumors and misinformation about companies. In issuing it, the SEC believed it could halt the spread of false information that could potentially drive down a company’s share price when investors short sell a company’s stock. This practice is illegal.
One group certain to weigh in on the short selling ban will be hedge funds. Since the ban on short sales began, hedge funds have endured record redemptions, the likes of which even giants such as Citadel Investments are not immune to.
It’s clear that one certain impact of the ban has been to send many investors to the sidelines. Just look at the trading volume of these companies since the ban was announced:
Wells Fargo: - 45%
Bank of America: - 53%
Nasdaq research that looked at the market’s reaction during the week before and the week after the ban indicated that the percentage trading in the market that could be categorized as short selling on shares of financial companies slid from 44% to 16%.
Some will argue that the ban on short selling fueled a deeper slide in markets as global markets from Hong Kong to London are being hammered. Through Tuesday, the Dow has slipped 14%, from 11,015 to 9,447, since the ban on short sales took effect on September 22. Shares in financials are down 23%, indicating the ban has had little impact. Advocates of short selling, particularly their most vocal supporters, hedge funds, will argue that short selling was not the reason for the decline of financial stocks and broader markets. Conversely, they’ll contend that the ban exacerbated the slide by removing much needed liquidity from the market.
Taking a step back, the SEC has been concerned with short selling for some time. Last summer it the so-called “uptick” rule, a regulation that was created in 1938 to limit short selling during declining markets. Under the rule, traders were prohibited from selling short a stock except in cases when the price moved higher. What it really did was prevent piling on – punishing a stock when it was already down to the detriment of the company and everyone else except for short sellers.
The SEC continued to look at short selling as the markets declined this summer. In July, the SEC took further steps to limit the negative impact of false rumors and speculation. It banned short selling on 19 financial institutions from July 21-29 including JP Morgan, Fannie Mae, Freddie Mac, UBS, Morgan Stanley, Citigroup, Bank of America, Lehman Brothers and Goldman Sachs.
In sum, it’s difficult to say with certainty whether the ban on short selling caused markets to deteriorate further. Markets thrive on information and owners of securities can quickly become sellers on the basis of rumors. This uncertainty can lead to panic or confusion. Also unclear is what the impact will be on markets when short-selling returns. Not surprisingly, many investors believe stocks could get a boost as short sellers will resume to buying and selling shares with greater frequency. Should this happen, it remains to be seen whether or not it is because of increased liquidity of that the bailout, rate cuts and fundamentals have spurred a hint of optimism.
Short-selling just add to the wild fluctuation. I doubt it affects the general trend. For it is more related to the market fundamentals.
Posted by: Trade Meme | October 09, 2008 at 05:08 AM