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What is short selling and how does short selling help the market and investors?

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What is short selling and how does short selling help the market and investors?
posted Jul 4, 2017 by Ananya Saha

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Most investment analysts agree that short selling is ethical. Despite the belief that the practice represents profiting off others' misery or that it depresses successful companies' share prices, both academic studies and real-world experiments have shown that short sales improve market efficiency.

In a short sale, investors go against the buy low, sell high strategy, considered to be investing basics, by selling a security with the expectation of buying it back after a price drop, profiting off the loss in share price. Typically, an investor taking a short position does not own the shares prior to the transaction, but borrows them from another investor. The risk to the short seller is that the security's price could increase, instead of fall, and trigger a loss when he or she must buy it back at a higher cost.

While it is true that investors with a short position in a security make money when the price of that security declines, that does not necessarily mean that profit for a short seller equals a loss for everyone else. For instance, if a security is overvalued by the market, investors may not be willing to purchase it at its market price. A short seller in this case would profit from the security's price returning to its true value, and investors unwilling to pay the inflated price could then purchase the security at the lower price.

Short selling strengthens the market by exposing which companies' stock prices are too high. In their search for overvalued firms, short sellers can discover accounting inconsistencies or other questionable practices before the market at large does.

answer Jul 4, 2017 by Mukul Chag
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