tag:theconversation.com,2011:/us/topics/short-selling-3851/articlesShort selling – The Conversation2023-02-02T19:16:33Ztag:theconversation.com,2011:article/1989912023-02-02T19:16:33Z2023-02-02T19:16:33ZShort selling Adani: how an obscure US firm profited from triggering the Indian giant’s price plunge<figure><img src="https://images.theconversation.com/files/507763/original/file-20230202-3961-nxfh9e.jpeg?ixlib=rb-1.1.0&rect=0%2C134%2C733%2C392&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Sam Shere/Wikimedia Commons</span></span></figcaption></figure><p>A few weeks ago, Gautam Adani was indisputably India’s richest man. </p>
<p>Now his fortune is slipping away as the stocks of his many companies crash, thanks to the efforts of a relatively obscure US company named after the 1937 Hindenberg disaster (in which a hydrogen-filled airship caught fire, killing 98 people).</p>
<p>Adani’s personal fortune was an estimated <a href="https://www.forbes.com/india-billionaires/list/">US$150 billion</a> in 2022. He catapulted past the previous richest Indian, Mukesh Ambani, on the back of the meteoric rise of Adani Group, a multinational conglomerate with holdings in <a href="https://www.adanienterprises.com/businesses/mining-and-mdo/australia">mining</a>, energy, airports, <a href="https://www.adani.com/newsroom/media-release/adani-becomes-indias-second-largest-cement-player">cement</a>, <a href="https://www.adanienterprises.com/businesses/edible-oil-and-foods#:%7E:text=Besides%20oil%2C%20AWL%20has%20also,%2C%20Fryola%2C%20Alpha%20and%20Aadhar.">food processing</a> and <a href="https://www.adanidefence.com/small-arms">weapons manufacturing</a>. </p>
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<img alt="Gautam Adani is no longer India's richest person." src="https://images.theconversation.com/files/507785/original/file-20230202-18-5ckpcj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/507785/original/file-20230202-18-5ckpcj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/507785/original/file-20230202-18-5ckpcj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/507785/original/file-20230202-18-5ckpcj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/507785/original/file-20230202-18-5ckpcj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=502&fit=crop&dpr=1 754w, https://images.theconversation.com/files/507785/original/file-20230202-18-5ckpcj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=502&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/507785/original/file-20230202-18-5ckpcj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=502&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
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<span class="caption">Gautam Adani is no longer India’s richest person.</span>
<span class="attribution"><span class="source">Aijaz Rahi/AP</span></span>
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<p>Since January 25, Adani Group’s stock price has fallen 45%. The catalyst? An <a href="https://hindenburgresearch.com/adani-response/#_ftnref1">explosive report</a> published on January 24 by Hindenburg Research, alleging Adani Group engaged in “brazen stock manipulation and accounting fraud scheme over the course of decades”.</p>
<p>What complicates this report is that Hindenburg Research isn’t just a research company. It’s an “activist short seller”, with a financial incentive in seeing Adani’s stock price fall. </p>
<p>Hindenburg makes its profits by identifying “man-made disasters floating around in the market”. It bets on the stock falling, then publicises that company’s negatives – including doing so <a href="https://hindenburgresearch.com/adani/">in Adani’s case</a>:</p>
<blockquote>
<p>After extensive research, we have taken a short position in Adani Group Companies through US-traded bonds and non-Indian-traded derivative instruments. </p>
</blockquote>
<p>Adani’s <a href="https://www.adani.com/-/media/Project/Adani/Invetsors/Adani-Response-to-Hindenburg-January-29-2023.pdf">response</a> includes calling the report a “calculated attack on India” and “intended only to create a false market in securities to enable Hindenburg, an admitted short seller, to book massive financial gain through wrongful means at the cost of countless investors”.</p>
<p>Activist short selling is certainly controversial. But it’s not necessarily illegal, nor unethical.</p>
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Read more:
<a href="https://theconversation.com/unpicking-the-labyrinth-that-is-indias-adani-74552">Unpicking the labyrinth that is India's Adani</a>
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<h2>How does short selling work?</h2>
<p>Short selling (also known as having a “short exposure”, or “shorting”) is essentially betting on a company’s stock falling. </p>
<p>The process is more complicated than betting on a share price rising, for which all you have to do is buy the stock and wait for it to appreciate. </p>
<p>It can be done in several ways. The most common is to sell borrowed stock. The “short seller” makes a contract with a share owner to borrow shares for an agreed period. They then sell that stock, banking the proceeds. When the time comes to return the stock, they buy shares on the market to “repay” the loan. If the price has fallen in the meantime, they make a profit. </p>
<p>There are also methods that involve “derivatives”. These are financial instruments that allow investors to “bet” on financial outcomes. For example, a “put option” involves betting a stock’s price will fall below a specific level (called the strike price). Similarly, a futures contract pays out the difference between the current stock price and the future stock price. This allows the investor to effectively bet on price movements. </p>
<p>Investors might also invest via bonds. A corporate bond is much like a loan. Investors can short sell a bond like they would a stock. Alternatively, they can buy “credit default swaps”, which enable betting on a company defaulting on on its debt repayments.</p>
<p>There are even more complicated strategies than these. For fun explanations, check out the 2015 movie The Big Short, about the guys who bet on the collapse of the subprime mortgage market that led to the 2008 Global Financial Crisis. </p>
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<figcaption><span class="caption">Short selling explained by Margot Robbie in ‘The Big Short’.</span></figcaption>
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<h2>Is short selling legal?</h2>
<p>There are two main legal issues arising with short selling.</p>
<p><strong>Market manipulation</strong>. It is illegal in most jurisdictions for activist short sellers to profit by spreading false or misleading information. This is the case in Australia and the US (where Hindenburg and some of its positions in Adani are based). But this is relatively easy to discover.</p>
<p><strong>Insider trading</strong>. it would be illegal to bet on a company’s future share price using information that is not generally available, then reveal that information.</p>
<p>On this, Hindenburg Research is skating on thin ice with some of its assertions. For example, its report says of Adani’s deals to build a rail line to transport coal in Queensland:</p>
<blockquote>
<p>None of the transactions were specifically disclosed in the Adani Enterprises annual reports. We uncovered them only by reviewing financials for the private Singaporean Carmichael Rail entity.</p>
</blockquote>
<p>If those financials were <strong>publicly</strong> available in a database or online, Hindenburg Research is in the clear. But if the financials were not generally available, it risks being accused of insider trading. </p>
<p>However, Hindenburg’s report contains many allegations involving a large volume of public information, which means it would be difficult to establish whether it also used any non-public information to assemble the report. </p>
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Read more:
<a href="https://theconversation.com/vital-signs-asics-crusade-against-activist-short-sellers-will-be-bad-for-regular-folk-161906">Vital Signs: ASIC's crusade against activist short sellers will be bad for regular folk</a>
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<h2>Is this ethical? Should we be concerned?</h2>
<p>There are some concerns about the ethics of profiting from a company’s demise. </p>
<p>Ethics can be arbitrary. However, we can consider some guidelines. These include: </p>
<ul>
<li><p>Does society benefit from information about fraud coming to light?</p></li>
<li><p>If there were no financial incentive, would a company really spend two years doing detailed forensic analysis?</p></li>
<li><p>Does anyone unfairly lose to justify rules or laws to discourage such profits?</p></li>
</ul>
<p>Exposing fraud is in the public interest. There must be some financial incentive to do such work. Existing shareholders are losing from Adani’s stock tumble, but that should properly be credited to the alleged fraud, not the report. </p>
<p>Ultimately, then, companies such as Hindenburg are generally a net positive if they comply with all relevant laws, securities regulations and privacy guidelines. </p>
<p>If the report is truthful, blaming Hindenburg for Adani’s crash is like blaming an alarm for a fire.</p><img src="https://counter.theconversation.com/content/198991/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Mark Humphery-Jenner receives funding from the Australian Research Council and AFAANZ.</span></em></p>Activist short selling is certainly controversial. But it’s not necessarily illegal nor unethical.Mark Humphery-Jenner, Associate Professor of Finance, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1619062021-06-03T20:12:08Z2021-06-03T20:12:08ZVital Signs: ASIC’s crusade against activist short sellers will be bad for regular folk<p>The Australian Securities & Investment Commission issued <a href="https://asic.gov.au/regulatory-resources/markets/short-selling/activist-short-selling-campaigns-in-australia/">an information sheet</a> this week regarding so-called “activist short selling”. </p>
<p>The document outlines a number of “better practices” it wants short sellers to adhere to, and some “actions that we may take” if they don’t. </p>
<p>Translation: “Hey hedge-fund folks, do this stuff or we’ll make life difficult for you.”</p>
<p>The problem is not that the corporate regulator can’t do so. It is that these “better practices” are likely to lead to less efficient markets. </p>
<p>In short (pun absolutely intended), this is bad idea.</p>
<h2>What is activist short selling?</h2>
<p>Short selling involves selling a security (like a share of stock in an exchange-listed company) you don’t own. The way this is typically done is to borrow that security from someone who does own it, with a promise to return it at a later date.</p>
<p>The idea is that when the security goes down in price, you can buy a replacement security for the person you borrowed from at a cheaper price than what you sold theirs, thus pocketing the difference.</p>
<p>Basically it’s a bet that the price of something is going to go down. For an alternative explanation see this scene from <a href="https://en.wikipedia.org/wiki/The_Big_Short_(film)">The Big Short</a>, the 2015 film about the housing bubble and subprime mortgage crisis that led to the Global Financial Crisis of 2007-2008.</p>
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<figcaption><span class="caption">Short selling explained by Margot Robbie in ‘The Big Short’.</span></figcaption>
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<p>Activist short selling involves taking a short position and then publicising it. This could be through media interviews, social media posts or otherwise providing detailed accounts of concerns with the target entity.</p>
<p>Perhaps the best example of this was investor George Soros’ <a href="https://www.forbes.com/sites/steveschaefer/2015/07/07/forbes-flashback-george-soros-british-pound-euro-ecb/?sh=11aa23b76131">1992 bet against the British Pound</a> (and other currencies) he rightly thought were overvalued against Germany’s Deutsche Mark and were being propped up by central banks like the Bank of England.</p>
<p>ASIC itself says its research indicates “activist short selling campaigns tend to target entities with complex and opaque corporate structures and accounting practices, or poor disclosure”.</p>
<p>So short selling can help discourage such practices. That’s a good thing. Yet ASIC wants to discourage shorting. What gives?</p>
<h2>Short selling improves market efficiency</h2>
<p>Why was there a housing bubble in the US in the early 2000s? </p>
<p>There were many causes, including absurdly lax lending standards and outright fraud by those issuing loans and the creation of complex financial products such as synthetic collateralised debt obligations (synthetic CDOs). </p>
<p>For an explanation of these see this, also from the Big Short, by Nobel prize-winning University of Chicago economist <a href="https://www.nobelprize.org/prizes/economic-sciences/2017/thaler/facts/">Richard Thaler</a> and the almost-as-famous actor and recording artist Selena Gomez.</p>
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<iframe width="440" height="260" src="https://www.youtube.com/embed/OsoY_MmdqZI?wmode=transparent&start=0" frameborder="0" allowfullscreen=""></iframe>
<figcaption><span class="caption">Thaler and Gomez on synthetic CDOs.</span></figcaption>
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<p>But there was also little that those who believed the housing market was dangerously overvalued could do to “bet against” it. </p>
<p>Eventually, as Michael Lewis’ book <a href="https://wwnorton.com/books/9780393072235">The Big Short: Inside the Doomsday Machine</a> (on which the movie is based) recounts, a handful of unusual characters managed to get Wall Street to create a specialised instrument called a “credit default swap” to let them do so.</p>
<p>Had there been an easy way to short the housing market earlier, the bubble might never have gotten out of control. The horrific crash of 2008 that caused the greatest financial crisis since the Great Depression might have been avoided.</p>
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<strong>
Read more:
<a href="https://theconversation.com/explainer-what-is-short-selling-9337">Explainer: what is short selling?</a>
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<h2>A check on ‘animal spirits’</h2>
<p>Why would short selling have helped?</p>
<p>Short selling punishes speculation by putting a check on out-of-control markets.
It motivates investors to keep an eye on fundamentals, not just get carried away with what John Maynard Keynes labelled “animal spirits” – the impulses that help drive speculative bubbles and busts.</p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/from-tulips-and-scrips-to-bitcoin-and-meme-stocks-how-the-act-of-speculating-became-a-financial-mania-158406">From tulips and scrips to bitcoin and meme stocks – how the act of speculating became a financial mania</a>
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<p>There’s only so much that can be done with the housing market, which is inherently difficult to bet against.</p>
<p>But Australia’s corporate regulator wants to restrict short selling in the stock market, in which it’s relatively easy to take a short position.</p>
<p>ASIC is obviously aware of the argument that short selling improves market efficiency, but has chosen to discount it. It has opted for rules that push Australia closer to European countries rather than the US – the largest, most liquid, and most important capital market in the world.</p>
<h2>Australian short sellers are being told to stop</h2>
<p>The corporate watchdog has outlined a number of “actions” it might take if short sellers don’t play ball:</p>
<ul>
<li>engaging with market operators (such as the Australian Stock Exchange) on the timing of trading halts</li>
<li>examining trading activity of short sellers, particularly “short and distort” campaigns</li>
<li>assessing if a short seller has conducted a financial service in Australia and holds the necessary licence</li>
<li>testing the veracity of claims and how conflicts of interest are disclosed</li>
<li>where an activist short seller is based abroad, engaging with their “home regulator”</li>
<li>taking action for breaches of the law.</li>
</ul>
<p>Many of these may sound mild but are in fact quite extraordinary. They constitute a (very) thinly veiled message that overseas hedge fund managers should knock it off with activist shorting in Australia.</p>
<p>This combines, to a remarkable degree, ugly nativism and regulatory capture – the phenomenon by which a regulator, even without malicious intent, comes to represent the interests of those it regulates, rather than the public good. (The theory of regulatory capture <a href="https://www.jstor.org/stable/3003160?casa_token=5wNw2MzeMCgAAAAA:LXphlOQWQ5nnt7DUjpK_gduPouVMEv1yie0_mONLBgCZghaAZKB0KraXdZi4G2Rng7jSmNJuR2dUFwkOnaggCQc-w406bzysj34IqdrmzWd459RI1uyrjA&seq=1">was pioneered by</a> another Chicago economist and Nobel winner, <a href="https://www.nobelprize.org/prizes/economic-sciences/1982/stigler/facts/">George Stigler</a>.) </p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/vital-signs-when-watchdogs-become-pets-or-the-problem-of-regulatory-capture-111170">Vital Signs: when watchdogs become pets – or the problem of 'regulatory capture'</a>
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<h2>Bubbles are bad for regular investors</h2>
<p>Who will breathe easier as a result of ASIC’s new guidelines? Companies with opaque accounting practices, inadequate corporate disclosures and even those that may be acting unlawfully.</p>
<p>The losers are equally easy to identify. Some rich hedge fund folks in Greenwich, Connecticut, sure. But also the Australian public, whose superannuation funds are invested in Australian markets.</p>
<p>We all have a big interest in ensuring the informational efficiency and market transparency. Bubbles are bad for regular investors. Regulations and securities laws play a crucial role in achieving those goals. So do activist short sellers.</p>
<p>ASIC should reconsider its stance. It will only serve to damage the credibility of Australian securities markets, the Australian public, and their own reputation as a wise regulator.</p><img src="https://counter.theconversation.com/content/161906/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Holden is president-elect of the Academy of the Social Sciences in Australia.</span></em></p>Activist short selling plays an important role in keeping financial markets accountable and efficient.Richard Holden, Professor of Economics, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1542842021-01-29T14:29:14Z2021-01-29T14:29:14ZGameStop: hedge fund attacks have opened up powerful new front against Wall Street<figure><img src="https://images.theconversation.com/files/381360/original/file-20210129-21-18iwj6c.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Wall Street under attack. </span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/new-york-city-ny-oct-11-240264190">Javen</a></span></figcaption></figure><p>In the dying days of 2009, Rage Against the Machine <a href="https://www.rollingstone.com/music/music-news/rage-against-the-machine-win-u-k-christmas-single-battle-187249/">achieved the</a> unlikeliest of Christmas number ones with a re-release of their anti-establishment anthem Killing in the Name. This was driven by an online campaign to give a great festive bloody nose to Simon Cowell, whose latest X-Factor winner was denied their routine annual spot at the top of the charts. </p>
<p><a href="https://journals.equinoxpub.com/PMH/article/view/14455">That protest</a> against a creatively bankrupt mainstream pop media became a case study in the power of an online crowd with a strong narrative. It finds echoes today in a very different arena: the current attack on Wall Street hedge funds by retail traders via the Reddit forum r/WallStreetBets. </p>
<p>When exchanges opened in the New Year, shares in GameStop, a Texas-based chain of computer games stores, were swapping hands at US$19 (£14) each. By the close on Tuesday January 26 they were worth US$347 – an increase of over 1,700%. </p>
<p><strong>GameStop price action</strong></p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/381357/original/file-20210129-23-1clw92k.png?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="The GameStop share price chart" src="https://images.theconversation.com/files/381357/original/file-20210129-23-1clw92k.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/381357/original/file-20210129-23-1clw92k.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=327&fit=crop&dpr=1 600w, https://images.theconversation.com/files/381357/original/file-20210129-23-1clw92k.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=327&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/381357/original/file-20210129-23-1clw92k.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=327&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/381357/original/file-20210129-23-1clw92k.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=411&fit=crop&dpr=1 754w, https://images.theconversation.com/files/381357/original/file-20210129-23-1clw92k.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=411&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/381357/original/file-20210129-23-1clw92k.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=411&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://uk.tradingview.com/chart/?symbol=NYSE%3AGME">TradingView</a></span>
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<p>Driven by a David v Goliath <a href="https://www.theguardian.com/commentisfree/2021/jan/28/anarchy-in-jokes-and-trolling-the-gamestop-fiasco-is-4chan-think-in-action">narrative of revenge</a> against previously untouchable Wall Street <a href="https://www.marketwatch.com/story/reddit-moderator-slams-wall-street-fat-cats-as-gamestop-surge-continues-they-hate-that-you-played-by-the-rules-and-still-won-11611600048">“fat cats”</a>, the surge was coordinated by the <a href="https://www.reddit.com/r/wallstreetbets/">almost 5 million members</a> of WallStreetBets, using apps like Robinhood that allow anyone to trade financial securities and derivatives for little or zero commission fees. <a href="https://www.reddit.com/r/wallstreetbets/comments/l7ly4a/people_are_risking_their_lives_to_wage_war/">In the words</a> of one of these traders: </p>
<blockquote>
<p>People are risking their lives to wage war against the suits and it brings tears to my eyes to watch them do it.</p>
</blockquote>
<h2>Beaten at their own game</h2>
<p>This produced <a href="https://www.bloomberg.com/news/articles/2021-01-25/gamestop-short-sellers-reload-bearish-bets-after-6-billion-loss">an estimated US$6 billion</a> in stinging losses for hedge funds and activists “short selling” GameStop shares. <a href="https://theconversation.com/why-gamestop-shares-stopped-trading-5-questions-answered-154255">Short selling</a> is a bet on stock prices going down, and is done by borrowing shares, selling them, and then buying them back later to return to the lender – hopefully at a reduced price. </p>
<p>Critics argue that hedge funds that engage in short selling have an incentive to push down prices in questionable ways, such as spreading negative rumours about the company’s future. The practice was <a href="https://www.ft.com/content/f59fdd00-93b0-11dd-9a63-0000779fd18c">blamed to some extent</a> for major financial institutions going into freefall during the global financial crisis in 2008. </p>
<p>By buying GameStop to hurt those with short positions, retail investors employed a classic Wall Street tactic that hedge funds use against one another. Buying enough shares to cause the price to surge forces short-selling hedge funds to buy back the borrowed shares at a higher price to cover their positions, which in turn pushes the price higher. In Wall Street parlance, it’s the “<a href="https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/short-squeeze/">short squeeze</a>”.</p>
<p>Hedge funds like Melvin Capital had to swallow soaring losses as the share price hit certain levels and triggered “margin calls” where they had to immediately repay their lenders. Melvin only survived thanks to a <a href="https://www.bloomberg.com/news/articles/2021-01-25/citadel-point72-to-invest-275-billion-in-melvin-capital">cash injection</a> of US$2.8 billion from other hedge-fund backers. </p>
<p>In previous years, such an attack would have been quickly swept aside by the larger firepower of hedge funds and established Wall Street institutions. Activist short sellers also kept the lid on things by publishing damning research on targeted firms. <a href="https://www.tandfonline.com/doi/abs/10.1080/1351847X.2017.1288647">Our study from 2017</a> demonstrated that a short-seller thesis can almost instantaneously affect online message board sentiment and send investors fleeing. </p>
<p>The difference now is retail investors’ much better access to the financial markets, swelling their numbers and their ability to collectively move prices. <a href="https://www.businessofapps.com/data/robinhood-statistics/">The number of users</a> on Robinhood has increased from 500,000 in 2014 to 13 million in 2020, and <a href="https://www.cnbc.com/2020/05/21/many-americans-used-part-of-their-coronavirus-stimulus-check-to-trade-stocks.html">trading stocks is</a> the most common use for the US government pandemic stimulus cheques in almost every age bracket. </p>
<h2>The empire strikes back</h2>
<p>Robinhood and other trading platforms <a href="https://techcrunch.com/2021/01/28/robinhood-users-say-its-restricting-trades-after-the-gamestop-brouhaha-shakes-markets/?guccounter=1&guce_referrer=aHR0cHM6Ly93d3cuZ29vZ2xlLmNvbS8&guce_referrer_sig=AQAAAKVZoI-2xGukI5bpebZ1sL5B_FiIUxeOfT093ha7bDkyXigvWCgZFHvsERADuQ8cc7S4QJ304tzjWBI63Q1DfRzGaAJ9Rv-pfMNmE7dKWO6kXdJX1lhPnTpZsWtZGG2XPt9IgkC8AWX1InzghEYhXbGNEYDwoXXOjBL19Tdv8oh4">banned trading in GameStop shares</a> around the time they peaked, sparking outrage at a perceived “rigged” game tilted towards the big players. Both <a href="https://twitter.com/tedcruz/status/1354833603943931905">Democratic and Republican senators have condemned</a> this decision to block retail investors while hedge funds can continue to trade. The platforms <a href="https://www.ft.com/content/9a1b24e6-0433-462a-a860-c2504ea565e4">claim they had to</a> impose temporary suspensions to protect their own financial positions from the risk of targeted stocks tumbling and retail traders who have borrowed to maximise their buying power suddenly racking up losses they can’t afford to cover. </p>
<p>The debate over how regulators should respond to this conflict is meanwhile intensifying, raising the prospect of new rules that discriminate against retail investors. That could fatally undermine trust in the regulators, since they would effectively be saying it’s alright for Wall Street to employ short squeezes but not the little guys. </p>
<figure class="align-center zoomable">
<a href="https://images.theconversation.com/files/381358/original/file-20210129-21-1a6nqdr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="WallStreetBets on Reddit on a smartphone" src="https://images.theconversation.com/files/381358/original/file-20210129-21-1a6nqdr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/381358/original/file-20210129-21-1a6nqdr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=400&fit=crop&dpr=1 600w, https://images.theconversation.com/files/381358/original/file-20210129-21-1a6nqdr.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=400&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/381358/original/file-20210129-21-1a6nqdr.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=400&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/381358/original/file-20210129-21-1a6nqdr.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=503&fit=crop&dpr=1 754w, https://images.theconversation.com/files/381358/original/file-20210129-21-1a6nqdr.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=503&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/381358/original/file-20210129-21-1a6nqdr.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=503&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
<figcaption>
<span class="caption">You betcha.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/wallstreetbets-reddit-group-seen-on-smartphone-1904689579">mundissima</a></span>
</figcaption>
</figure>
<p>Either way, these events have brought issues to the fore that regulators would have needed to address further down the road anyway, since the trading game has clearly changed in the last couple of years. For example, one new danger is an unfriendly foreign country feeding “fake news” into social media to enrage retail investors about perceived unfairnesses, which galvanises them into attacks that prevent the markets from working efficiently. </p>
<p>After all, some would argue that short sellers are unfairly portrayed as villains in this David v Goliath battle. <a href="https://www.sciencedirect.com/science/article/pii/S0304405X01000563?casa_token=u4L2JAt7vZoAAAAA:eCkMlssnABzzZ14XO98rEdW2XQNpll_IN0SURLvhRw2S2amdPR5ougSaq_Z2K8_bcKn98wfx">They help</a> to <a href="https://www.economist.com/leaders/2020/06/24/wirecards-scandal-shows-the-benefits-of-short-sellers">keep markets liquid</a> by making share purchases easier for those who do want to buy a particular stock, and they can put a spotlight on companies that are <a href="https://academic.oup.com/rfs/article-abstract/28/6/1701/1610243">poorly managed</a>, <a href="https://repositories.lib.utexas.edu/handle/2152/74990">dishonest</a>, or <a href="https://journals.sagepub.com/doi/full/10.1177/0148558X17748524?casa_token=ccIf5rD3WD4AAAAA%3AcfVd7JdLyEBBTcoxNQk1ayEKZkU-qZoMoxcmmamMbH3rwIwXiNxKSsqXrMLNSil4XzAWTzpWaPU">engaged in poor corporate governance</a>.</p>
<p>As a <a href="https://www.nytimes.com/2017/06/08/magazine/the-bounty-hunter-of-wall-street.html">New York Times profile</a> of notorious short-seller Andrew Left states, “In a town with a dozing sheriff, vigilantes become the agents of order.” Left’s fund, Citron Capital, <a href="https://markets.businessinsider.com/news/stocks/citron-gamestop-reddit-short-position-covered-loss-reddit-andrew-left-2021-1-1030009872">made a 100% loss</a> on its short position in GameStop. </p>
<p>So how should the regulators play this? They may not want to curb investor discussion in online communities, even if it were possible, or try and set parameters about constitutes “manipulation” and “honest discussion” of a particular stock. One option might be to increase their monitoring capacity, perhaps through some kind of early-warning system based on the volume of online chatter and the sentiment being expressed. They could feed this information to the trading platforms to let them take a view on temporarily limiting trading on those securities. </p>
<h2>I won’t do what you tell me …</h2>
<p>Nobody knows how the present situation will end. The intense activity by retail investors could prompt a wider sell-off by forcing hedge funds with short positions to sell other shares to raise the cash to cover their losses. This could hurt companies and investors that were only spectators in this battle, with potentially far-reaching consequences. </p>
<p>For those worried about the potential for chaos, Rage Against the Machine might offer a crumb of comfort. Since that Christmas number one, numerous attempts to achieve a similar feat have been less successful. The collective action was diluted by the sheer number of copycat campaigns. </p>
<p>Similarly, we have seen campaigns by traders launched against Blackberry and AMC Entertainment, and there are rumours of a similar strategy being employed against American Airlines. Whether they reach similar levels as GameStop remains to be seen. </p>
<p>Either way the crowd will regroup, and regulators will need to learn valuable lessons from this episode. Having shown what a crowd of renegade investors can achieve, this could well have opened up a powerful new front in anti Wall Street activism.</p><img src="https://counter.theconversation.com/content/154284/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The question is if and how the regulators can respond.James Bowden, Lecturer in Financial Technology, University of Strathclyde Edward Thomas Jones, Lecturer in Economics, Bangor UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/93372012-10-25T04:14:30Z2012-10-25T04:14:30ZExplainer: what is short selling?<figure><img src="https://images.theconversation.com/files/15497/original/qmct3sxr-1347840963.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Are short sellers heroes or villains of financial markets?</span> <span class="attribution"><span class="source">Image from www.shutterstock.com</span></span></figcaption></figure><p>Short sellers are often portrayed by the media to be the villains of the financial markets. They are usually presented as evil traders that drive down the prices of good companies. However, the academic research on short selling typically provides evidence more consistent with them being heroes. They identify over-valued companies and help restore more accurate prices. They also provide liquidity to the market. </p>
<p>Recent regulations that banned short selling have been shown to have a detrimental rather than beneficial impact on markets.</p>
<p><strong>What is short selling?</strong></p>
<p>Short selling means that you are selling something that you do not own. Most people struggle to understand how this is possible or why it is allowed. A short seller will sell a stock if they believe the price of the stock is going to decline in the future. Therefore, they sell at a high price in the hope of buying the stock back when the price declines. </p>
<p>In order to short sell, the seller must borrow the stock from someone who owns it. In return, the short seller pays a fee to the party lending them the stock. In addition, if the price of the stock rises after the short seller sells the stock, they will also be required to pay a margin to cover the potential loss of the short seller being required to buy the stock back at a higher price. When the short seller buys back the stock, the stock loan is terminated. The short seller’s profit or loss is the difference between the sale price and the purchase price.</p>
<p>Short selling is more risky than buying a stock because the potential losses are unlimited. When someone buys a stock, the maximum amount that they can lose is the price they paid for the stock. When someone short sells a stock, they lose more as the price of the stock rises.</p>
<p><strong>How common is short selling?</strong></p>
<p>Short selling is common. In the US equity market, short selling accounts for approximately <a href="http://ssrn.com/abstract=1787677">40% of the dollar value traded</a>. In Australia, the level of short selling is considerably lower at around <a href="http://asianfa2012.mcu.edu.tw/fullpaper/10481.pdf">13% of the dollar value traded</a>.</p>
<p>Since the financial crisis, the Australian regulators have introduced a comprehensive disclosure regime for short selling. This regime makes it easy for market participants to identify the outstanding short positions and the level of shorting activity in the market. Short positions must be reported to ASIC on a daily basis. ASIC aggregates this information and <a href="http://www.asic.gov.au/asic/asic.nsf/byheadline/Short+position+reports+table?openDocument">reports a daily aggregate level of short positions outstanding to the market</a>. In addition, the level of short selling activity must be reported to the Australian Securities Exchange (ASX) on a daily basis. ASX <a href="http://www.asic.gov.au/asic/asic.nsf/byheadline/Short+position+reports+table?openDocument">aggregates this information</a> and reports the aggregate daily level of short selling in each stock to the market.</p>
<p><strong>What can we learn from short sellers?</strong></p>
<p>High levels of short selling in a particular stock suggest that the market perceives that stock to be overvalued. Academic research in the US has shown that short sellers are informed investors. Heavily shorted stocks underperform lightly shorted stocks by <a href="http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2008.01324.x/abstract">approximately 15% per annum</a>.</p>
<p>This evidence suggests that short sellers are skilled at identifying overvalued stocks and that on average they are able to profit from taking a short position in these stocks.</p>
<p><strong>Do short sellers provide any other benefits?</strong></p>
<p>Short sellers also offer additional liquidity to the market. <a href="http://ssrn.com/abstract=1787677">Recent academic research</a> in the US market has shown that some short sellers act as liquidity providers – stepping into the market to provide liquidity when the cost of liquidity is high. <a href="http://www.finsia.com/eventPDF/16_22%20hamsonetal%20short%20selling%20jassa-n4-dec08_web.pdf">A study by an Australian fund manager</a> suggests that short sellers are also significant liquidity providers in the Australian market. This study showed that the ban on short selling by Australian regulators during the financial crisis resulted in significant reductions in liquidity.</p>
<p><strong>But can’t short sellers manipulate the market?</strong></p>
<p>Some investors and companies raise concerns about short sellers manipulating stock prices down in order to profit on their short position. Oddly, people seem to be less concerned about the price of a stock being manipulated upwards by someone with a long position in a stock. Regulatory attention should focus on detecting and prosecuting manipulative trading regardless of whether the manipulator is pushing the price of the stock up or down or whether the manipulator is a long or a short seller.</p><img src="https://counter.theconversation.com/content/9337/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Carole Comerton-Forde is an economic consultant for ASIC on market structure issues. She has not provided advice in relation to short selling. </span></em></p>Short sellers are often portrayed by the media to be the villains of the financial markets. They are usually presented as evil traders that drive down the prices of good companies. However, the academic…Carole Comerton-Forde, Professor of Finance, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.