Ban Short Selling

As I mentioned several times in my previous posts, I still think that SEBI, should think of banning the short selling.

Before continuing my point of view of banning short selling, I would like make clear what is short selling for the benefit of my readers.

Most of the traders/investors like my dad, don’t know about short selling and they are not interested also. That is good thing since at least these kinds of people are not participating in short selling there by providing some kind relief to the market.

Short selling is process in which a person, who is not holding any stocks, sells the stocks for higher value (by borrowing from the lender through broker) and buys back them for lower value and return it back to the original lender. Confused? Okay let me explain with an example.

Consider me a short seller. When I think market may go bearish, I as a short seller see which stock may fall more. For our understanding we will take HDFC example. If I think today HDFC may fall from Rs. 1600 to Rs.1400. Then I would like to cash this situation.

Here originally I will not be holding any stocks. So I borrow HDFC stocks from the lender in the market and immediately I sell them in the open market for Rs. 1600. Then I wait for market to fall and when HDFC reaches Rs. 1400 at that time I buy back the HDFC and return those shares to the original lender. So in this process I made profit Rs. 200/share.

And who all can do this? Any person who is having a margin account with his broker can participate in this kind of transaction. This margin account is used as collateral for borrowing the shares from the lender.

And according to SEBI your portfolio should be at least 50% of the amount what you are short selling. Means if your portfolio is worth of Rs. 10 lakh then you can take Rs. 20 lakh worth of short position.

I think you guys got fair enough idea about short selling now. Now I will come back to original point of discussion of banning short selling.

As you all know market works on the Supply/Demand theory. So whenever there is more supply in the form of selling or short selling at that time market start crumbling down. First of all in this kind of market, sentiments and news flows are negative so long term investors like FIIs, institutional investors and individuals are squaring of their position by selling their holdings. And to cover back their losses/to gain profit from this kind of market, these guys are taking short position by short selling.

So due to heavy supply in terms of selling, market is coming back to its three years lows (8700 levels). Market almost 60% from its peak in January 2008. Highest number of 500 points loss in single trading days. Even small pull back rallies are also due to square of position in the short position by short covering. Once big fellows like FIIs start taking short position then retail investors like you and me can’t do anything but just watch the crumbling down of the market.

So why shouldn’t SEBI ban this short selling? According to some experts short selling should be there in the market to know the intrinsic value of the shares and market. They think that short selling provides floor value to the market, since short positions should be cleared within the stipulated time where as in long position person can hold his stocks for 500 years from the date of purchase. They think short selling is the instrument for the EFFICIENT MARKET HYPOTHESIS.

But I don’t know why they don’t understand the need of the hour??? Why they don’t think giving some temporary relief to the market and in turn to the sentiments of the investors? Why don’t they understand the FLOOR value come into picture in BULL market not in BEAR market? Why they don’t understand that in this time of CAPITULATION short selling leads SNOWBALLING EFFECT. Why don’t they consider market as efficient even after speculators almost tripled the price of the crude oil from $ 39 to $ 147 within 4 years? Why don’t they think about erosion of investor’s wealth? Why don’t they think of role of intervention of regulator/government in this of panic situation to console the crumbling market? Why don’t they think about the GREAT DEPRESSION which started from stock market fall which went on 90% fall from the peak? Why don’t they think stock market panic is spreading to FOREX market and in turn causing panic importers?

I am not saying short selling should be banned permanently. But what I am saying is ban the short selling temporarily for example till January/February or so. So by that time almost dust of this financial meltdown may start settling down. Domestically also inflation might have come into control and also liquidity might be available by that time by banks due to rate cuts. So investor start gaining their confidence in the market.

BOTTOM LINE…

SEBI should think about this!!!