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04/09/15
09:56
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Originally posted by Mightyatom
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hindmost is correct to describe shorting as new shares. Not in a literal sense but in the sense of having the same impact as if new shares were issued. Reason:
The share registry consists of numerous holders with a view on the stock - theoretically, in the absence of news to change their longer term view, they remain holders = xxxxx number of shares.
Add a shorter and it borrows the stock from one/more of those holders. Now we have a share with two entities holding a beneficial interest (shorter and holder). The holder wouldn't have sold but the shorter will sell. Result, a seller of shares who would not have existed had it not been for the lender.
There is a valid argument to say the share is split in two (new shares) the shorter has one and the original owner retains one. The bona-fida argument is it provides liquidity in what otherwise could be a lifeless market. It enables willing buyers to acquire stock at what is deemed a fair price -lower. Price discovery.
The problem is wherever there is an attempt to add sophistication to a market, derivatives and the like, people will find a way to use the method to drive profits. So we have moved from shorting to find a fair price where willing buyers and sellers will interact fluidly to one of speculation where those with the financial resources to force a position will do so. The demand side will step aside in the face of heavy weight selling creating a distortion of the market. Why not buy if the price is good? Because those selling have a virtual unlimited ability to keep pressure on the price. It would take a very big budget to offset the shorter, why fight it when the shorter will give a buyer a better price in coming days, weeks, months. The smaller retail buyer can take small chunks but the big insto' needing large volume would have to have the stomach to fight it off, better wait until the shorter reverses position - and they will know when that time comes.
While new shares are not issued, shorting is a defacto issue of new shares it has a temporary impact of adding a far greater number of shares in to the supply side than would otherwise be there. As with any commodity when there is excess supply the price drops.
So yes, I agree with hindmost's assertion that extra supply is equivalent of temporary new issue of shares - diluting the holding. When the shorter closes the reverse happens supply shrinks and demand increases, equivalent to a buy-back.
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Thanks, Mightyatom. The more one thinks about it, the more reason there is to think that shorting should be banned. Take a not-too-big company that needs to raise cash. When they announce the price of a new share issue, shorters can pump shares into the market and drive the price below the issue price. That makes the new issue unattractive, so few will take it up, thus starving the company of its needed cash and damaging its business. Big win for the shorts, but economic destruction for everyone else.