There are many types of people who buy and sell securities. The most fundamental division is between speculators and investors. Simply put investors are people who think a particular enterprise will be successful and buy a security with the hope of long term growth. Speculators are focused on price movements and may or may not even consider the financial status of a company, but hope to profit from being right about how prices will change over some period of time.
Now I'm sure there are many who have alternate definitions, but I believe mine is simple and accurate. Generally, investor are fundamentalists, meaning they worry about things like balance sheets, cash flow, earnings, etc. Speculators may look at these things, but generally they are much more interested in short term trends and are interested in fundamentals only to the extent that they may impact price movements.
Speculation is generally criticised but speculators do serve a purpose similar to insurance in the marketplace. For example, speculators allow suppliers to hedge production costs. Without them the risks in business costs could be much less predictable. However, if you are a speculator, you are clearly taking significant risk, since the risk is transferred to the speculator and human nature leads speculators to look for ways to reduce that risk.
Similar to gambling, speculators are constantly searching for a "sure thing". Now, the only real way to have a sure thing is to be able to control the outcome. This is where speculation becomes problematic. In some markets opportunities arise for speculators to control the way prices move over a period of time. In the oil markets, there is significant belief that the price rise of 2008 was simply speculation created. More recently we had a situation where an individual trader was able to move oil futures on the overnight market and then pocket some profits on the reversals.
So is a situation where markets can be "fixed" even if only for short periods of time acceptable? I think most people would object to this as much as they would object to sporting events being fixed for the benefit of gamblers. The problem is that we have a lot of money and a lot of greed in play in speculation and regulators are unlikely to find a way to prevent the next "gimmick".
This doesn't mean they should stop trying.
One of the first things they can do is reign in naked short selling, where the number of shares being sold can be artificially increased. Making sellers identify the specific shares they are selling and reinstitution of the uptick rule are excellent steps that should be implemented quickly.
Showing posts with label short selling. Show all posts
Showing posts with label short selling. Show all posts
Friday, July 24, 2009
Sunday, July 12, 2009
AIG short selling
There are ongoing discussions concerning short selling of stocks. Those who use short selling extensively, and this includes many hedge fund managers are extremely defensive about the need for short selling. It certainly makes their job easier in the sense it provides a way to guard against downward movements in the market and actually make money while doing so.
The question that I have is has short selling become so commonplace that it has altered the very nature of the stock market? Yes short selling has been around for many years, but the tremendous growth of hedge funds, as opposed to regular mutual funds, and the increased use of short selling via discount brokers has made it a greater factor.
Clearly in a free market you can buy and sell product. It makes sense to buy and sell future promises related to those products in order to reduce risk. However, the idea of selling product that you have never owned becomes somewhat problematic. When short selling and especially "naked" short selling is a small percentage of total transactions it has limited impact. However, as the amount of short sales increase it creates a clear downward pressure on stocks that the short sellers never owned.
When short sellers start to see an opportunity because a stock hits certain indicators or simply because volume of short selling increases enough to get their attention, the number of shares for sale increase tremendously. There can be no counterbalancing group of buyers, except for early short sellers who cover earlier positions to lock in profits. The math on this is clear. For example if there is x stock in circulation, and it achieves a market price based on the number of sellers and buyers, an increase in sellers will cause downward pressure on the stock. For the short sellers who enter the market, there is no comparable group of buyers who can buy stock without actually owning it. Since the stock sold is actually still accounted for in someones account, effectively the number of shares in circulation is increased and the value receives downward pressure.
Yes, all short sellers must at some point cover their positions and effectively remove the fictitious stock from circulation. This theoretically will return the stock to its prior starting point, assuming the volatility hasn't scared of real investors.
Now, short sellers like to argue that they help to expose weak stocks. Not sure who asked them to do that and further, curious as to whether those stocks were that weak before the short sellers started a selling panic. Recently we saw shares of AIG hammered. Now, long term investors in AIG were punished as millions of shares of AIG stock were sold by people who had never owned it. It was such an obvious and easy target that the stock after undergoing a 1 to 20 stock split quickly lost 50 % of its value. Now when it was selling at penny stock levels, it wasn't that attractive a short selling target because there is a point when even a weak stock like AIG appeals to bottom feeders. Once the reverse split went into effect, short interest rose 14.5 percent in the company. About 262 million of the company's shares were held short, just below 10 percent of its shares outstanding on June 30, the day the company approved a 1-for-20 reverse split that was effective July 1.
After the stock plummeted, short interest declined as profit was taken and the stock had a modest rebound, with short interest down to about 8.5%. Now is AIG a bad company with a bad stock? I think that the answer to that is yes. However without short sellers how would the stock have behaved? For those investors holding the stock, many of them still holding on to it from earlier times when it was quite high, the likelihood that they would sell now was slim. There are no institutional holders of the stock so all the stock is actually held either by company employees or private investors, hoping for some eventual recovery. So the only real sellers would be that group of short sellers, that sold nearly 10% of the stock into a non receptive market.
What legitimate investment purpose was served by this? Yes, a number of short sellers made a lot of money and a lot of investors watched their holdings go artificially lower. As AIG has rebounded a bit, short sellers are going to have to cover positions and it is possible that the stock will return close to the level it had before the assault. Of course as it does rise, short selling will increase again.
Now clearly short selling is gambling. There are other ways to bet on whether stocks go up or down outside of actually owning them i.e. the options market, but when you sell a stock short you actually influence the market to some extent. When 10% of a stock is sold short, it is clearly significant enough to drive prices down. I have a problem with this, especially since the numbers involved have increased to the extent they have.
So should the SEC impose restrictions on short selling? I know free market advocates feel that it is unnecessary. I don't really care if people want to gamble. What strikes me as problematic here is that the gambling gets to influence the outcome. If the gambling was simply a bet on whether the stock would go up or down, i.e. options, it wouldn't directly influence the market. However, if a very large hedge fund wants to manipulate a stock, it can sell a large number of those shares short and in all liklihood drive the prices down somewhat.
So is market manipulation a good thing? For those doing the manipulation it is, but not for everyone else.
The question that I have is has short selling become so commonplace that it has altered the very nature of the stock market? Yes short selling has been around for many years, but the tremendous growth of hedge funds, as opposed to regular mutual funds, and the increased use of short selling via discount brokers has made it a greater factor.
Clearly in a free market you can buy and sell product. It makes sense to buy and sell future promises related to those products in order to reduce risk. However, the idea of selling product that you have never owned becomes somewhat problematic. When short selling and especially "naked" short selling is a small percentage of total transactions it has limited impact. However, as the amount of short sales increase it creates a clear downward pressure on stocks that the short sellers never owned.
When short sellers start to see an opportunity because a stock hits certain indicators or simply because volume of short selling increases enough to get their attention, the number of shares for sale increase tremendously. There can be no counterbalancing group of buyers, except for early short sellers who cover earlier positions to lock in profits. The math on this is clear. For example if there is x stock in circulation, and it achieves a market price based on the number of sellers and buyers, an increase in sellers will cause downward pressure on the stock. For the short sellers who enter the market, there is no comparable group of buyers who can buy stock without actually owning it. Since the stock sold is actually still accounted for in someones account, effectively the number of shares in circulation is increased and the value receives downward pressure.
Yes, all short sellers must at some point cover their positions and effectively remove the fictitious stock from circulation. This theoretically will return the stock to its prior starting point, assuming the volatility hasn't scared of real investors.
Now, short sellers like to argue that they help to expose weak stocks. Not sure who asked them to do that and further, curious as to whether those stocks were that weak before the short sellers started a selling panic. Recently we saw shares of AIG hammered. Now, long term investors in AIG were punished as millions of shares of AIG stock were sold by people who had never owned it. It was such an obvious and easy target that the stock after undergoing a 1 to 20 stock split quickly lost 50 % of its value. Now when it was selling at penny stock levels, it wasn't that attractive a short selling target because there is a point when even a weak stock like AIG appeals to bottom feeders. Once the reverse split went into effect, short interest rose 14.5 percent in the company. About 262 million of the company's shares were held short, just below 10 percent of its shares outstanding on June 30, the day the company approved a 1-for-20 reverse split that was effective July 1.
After the stock plummeted, short interest declined as profit was taken and the stock had a modest rebound, with short interest down to about 8.5%. Now is AIG a bad company with a bad stock? I think that the answer to that is yes. However without short sellers how would the stock have behaved? For those investors holding the stock, many of them still holding on to it from earlier times when it was quite high, the likelihood that they would sell now was slim. There are no institutional holders of the stock so all the stock is actually held either by company employees or private investors, hoping for some eventual recovery. So the only real sellers would be that group of short sellers, that sold nearly 10% of the stock into a non receptive market.
What legitimate investment purpose was served by this? Yes, a number of short sellers made a lot of money and a lot of investors watched their holdings go artificially lower. As AIG has rebounded a bit, short sellers are going to have to cover positions and it is possible that the stock will return close to the level it had before the assault. Of course as it does rise, short selling will increase again.
Now clearly short selling is gambling. There are other ways to bet on whether stocks go up or down outside of actually owning them i.e. the options market, but when you sell a stock short you actually influence the market to some extent. When 10% of a stock is sold short, it is clearly significant enough to drive prices down. I have a problem with this, especially since the numbers involved have increased to the extent they have.
So should the SEC impose restrictions on short selling? I know free market advocates feel that it is unnecessary. I don't really care if people want to gamble. What strikes me as problematic here is that the gambling gets to influence the outcome. If the gambling was simply a bet on whether the stock would go up or down, i.e. options, it wouldn't directly influence the market. However, if a very large hedge fund wants to manipulate a stock, it can sell a large number of those shares short and in all liklihood drive the prices down somewhat.
So is market manipulation a good thing? For those doing the manipulation it is, but not for everyone else.
Saturday, July 4, 2009
Happy 4th of July!
Certainly hope everyone has a safe and happy holiday!
I've been reading about how the SEC is considering putting restrictions on short selling. Now it seems likely they will reinstate the uptick rule, a requirement that you can only short a stock after an uptick, but it made me start thinking about short selling.
I guess the more I think about it the greater problem it seems to be. Yes, short selling has been around for a very long time but the capability for short selling and the amounts involved have exploded with the growth of hedge funds. Its easy enough to find how much short interest there is on any individual stock but not as easy to see the amount of short selling in total. I did see one old chart that showed the amount of short selling increasing exponentially between the early 1960s and the early 1990s. Based on some more recent data, short interest on the NYSE was said to be about 4% of total shares which would support that the increase has continued.
So what about short selling? Short selling is a way to bet that a stock will go down without actually owning the stock. Yes, the stock will eventually need to be purchased to cover the short position and it can be a risky strategy but the other impact is that it has some impact on the supply and demand of a stock. Now, when the amount of short interest is negligible it can be absorbed by normal market conditions. The situation that concerns me is when short positions become a significant factor in the number of shares outstanding.
Assuming stocks reach a supply and demand equilibrium because the number of buyers and sellers at a particular level are approximately equal. You can increase the number of sellers by taking short positions. Now, the impact of this clearly depends on the amount of short sellers. Now the number of short positions is not spread evenly across all stocks. Certain stocks either because they have had recent run-ups or because they have some negative news, attract a great number of short sellers. In those situations they have a multiplier impact on the stock, meaning that more shares are on the market than would have been otherwise.
This increases volatility of the stock price. Now if you think of the stock market as something akin to a casino, this is OK. However, if you think the fundamental purpose of the stock market is to provide for a fairly orderly place to raise capital, it may not be a good thing. However, there are clearly times when short sellers become so numerous for a particular sector or stock that they endanger companies. Near the end of 2008 the SEC banned short selling of financial stocks for a 2 week period, Britain banned it for financial stocks for a longer period and Australia banned it altogether. Whether these actions helped or not may be debatable. There is also a theory that if a stock has a large short interest, it has a built in demand level since all these short holders will eventually have to buy the stock to cover their positions.
So what should the SEC do? As I said earlier they will probably re institute the uptick rule. Should there be additional restrictions? One possibility would be to restrict the amount of short interest that could exist on any particular stock. Since there are other ways to bet that a stock will go down or up, puts for example, is short selling a good idea at all? It is clearly a speculative position that generates fees for the brokerage. It does provide a way for hedge funds to "hedge" but do we care about that?
I'll wait and see what the SEC decides. I will say that with the amount of retirement funds tied up in the stock market, the American people don't want it to be a crap shoot. Prices should not be inflated, but selling shares you don't own is gambling, plain and simple. It may expose overvalued stocks or it may depress values below where they should be. Either way it is not an investment.
I've been reading about how the SEC is considering putting restrictions on short selling. Now it seems likely they will reinstate the uptick rule, a requirement that you can only short a stock after an uptick, but it made me start thinking about short selling.
I guess the more I think about it the greater problem it seems to be. Yes, short selling has been around for a very long time but the capability for short selling and the amounts involved have exploded with the growth of hedge funds. Its easy enough to find how much short interest there is on any individual stock but not as easy to see the amount of short selling in total. I did see one old chart that showed the amount of short selling increasing exponentially between the early 1960s and the early 1990s. Based on some more recent data, short interest on the NYSE was said to be about 4% of total shares which would support that the increase has continued.
So what about short selling? Short selling is a way to bet that a stock will go down without actually owning the stock. Yes, the stock will eventually need to be purchased to cover the short position and it can be a risky strategy but the other impact is that it has some impact on the supply and demand of a stock. Now, when the amount of short interest is negligible it can be absorbed by normal market conditions. The situation that concerns me is when short positions become a significant factor in the number of shares outstanding.
Assuming stocks reach a supply and demand equilibrium because the number of buyers and sellers at a particular level are approximately equal. You can increase the number of sellers by taking short positions. Now, the impact of this clearly depends on the amount of short sellers. Now the number of short positions is not spread evenly across all stocks. Certain stocks either because they have had recent run-ups or because they have some negative news, attract a great number of short sellers. In those situations they have a multiplier impact on the stock, meaning that more shares are on the market than would have been otherwise.
This increases volatility of the stock price. Now if you think of the stock market as something akin to a casino, this is OK. However, if you think the fundamental purpose of the stock market is to provide for a fairly orderly place to raise capital, it may not be a good thing. However, there are clearly times when short sellers become so numerous for a particular sector or stock that they endanger companies. Near the end of 2008 the SEC banned short selling of financial stocks for a 2 week period, Britain banned it for financial stocks for a longer period and Australia banned it altogether. Whether these actions helped or not may be debatable. There is also a theory that if a stock has a large short interest, it has a built in demand level since all these short holders will eventually have to buy the stock to cover their positions.
So what should the SEC do? As I said earlier they will probably re institute the uptick rule. Should there be additional restrictions? One possibility would be to restrict the amount of short interest that could exist on any particular stock. Since there are other ways to bet that a stock will go down or up, puts for example, is short selling a good idea at all? It is clearly a speculative position that generates fees for the brokerage. It does provide a way for hedge funds to "hedge" but do we care about that?
I'll wait and see what the SEC decides. I will say that with the amount of retirement funds tied up in the stock market, the American people don't want it to be a crap shoot. Prices should not be inflated, but selling shares you don't own is gambling, plain and simple. It may expose overvalued stocks or it may depress values below where they should be. Either way it is not an investment.
Tuesday, June 30, 2009
Citizen Obligations
I was reading comments on an application called stocktwits yesterday. The discussion concerned a specific investment and one person questioned how buying that investment helped the US Economy or was patriotic. The response was that the US Economy and patriotism wasn't their concern and that the Government should take care of those things.
In general, investment decisions normally have very little to do with Patriotism but you do have to wonder if there is any limit to greed. Yesterday Bernie Madoff got sentenced to 150 years in jail because he was greedy and proud. I really do think that he lost control of his Ponzi scheme at some point and it escalated beyond his control. He was too proud to admit that his greed was ruining hundreds of people and continued up until the last minute bilking unsuspecting investors out of their money.
So, consider a situation where a lot of money could be made but it would decimate the economy and cause tremendous hardship to millions of people? Is the fact that one or a small number of investors or speculators could get rich offset any obligation they have to their fellow citizens? I can pretty much guarantee that most active investors would feel that they should grasp the opportunity. Certainly to pass on this opportunity would only work if everyone also passed on it, otherwise you wouldn't make the money and end up as one of the losers.
There is some speculation that when Lehman went bankrupt and hedge funds and active investors sold all the bank stock they had and shorted all the bank stock they didn't have it precipitated the collapse in the stock market that wiped out the retirement funds of millions. There is some current controversy over whether the uptick rule should be re-instated (requires that a short sale must be made after an uptick in price). It certainly would have crimped a lot of the short selling, and it may have provided the retail investor time to adjust. Now, many of the short sales weren't printed because their were no buyers and the price simply plummeted. As usual the most money was made by the quickest.
Now, the collapse in the economy was a national and world disaster. We are still feeling the consequences and I wouldn't suggest that anyone should have been buying bank stocks in that time frame since it wouldn't have done any good. However, is there any limit?
In reading posts on financial networks, there are a group of posters who really seem to want the economy to collapse. They probably see that a lot more money can be made in a sudden collapse than in a slow recovery. Of course the desire for the economy to collapse isn't going to have any impact on what it actually does, but you wonder about those who wish for millions to suffer so they can benefit. Of course they argue that if they own property, or invest in the economy, they should sell everything and save what they can because Armageddon is coming.
There is a difference between preparing for Armageddon and trying to make it happen.
In general, investment decisions normally have very little to do with Patriotism but you do have to wonder if there is any limit to greed. Yesterday Bernie Madoff got sentenced to 150 years in jail because he was greedy and proud. I really do think that he lost control of his Ponzi scheme at some point and it escalated beyond his control. He was too proud to admit that his greed was ruining hundreds of people and continued up until the last minute bilking unsuspecting investors out of their money.
So, consider a situation where a lot of money could be made but it would decimate the economy and cause tremendous hardship to millions of people? Is the fact that one or a small number of investors or speculators could get rich offset any obligation they have to their fellow citizens? I can pretty much guarantee that most active investors would feel that they should grasp the opportunity. Certainly to pass on this opportunity would only work if everyone also passed on it, otherwise you wouldn't make the money and end up as one of the losers.
There is some speculation that when Lehman went bankrupt and hedge funds and active investors sold all the bank stock they had and shorted all the bank stock they didn't have it precipitated the collapse in the stock market that wiped out the retirement funds of millions. There is some current controversy over whether the uptick rule should be re-instated (requires that a short sale must be made after an uptick in price). It certainly would have crimped a lot of the short selling, and it may have provided the retail investor time to adjust. Now, many of the short sales weren't printed because their were no buyers and the price simply plummeted. As usual the most money was made by the quickest.
Now, the collapse in the economy was a national and world disaster. We are still feeling the consequences and I wouldn't suggest that anyone should have been buying bank stocks in that time frame since it wouldn't have done any good. However, is there any limit?
In reading posts on financial networks, there are a group of posters who really seem to want the economy to collapse. They probably see that a lot more money can be made in a sudden collapse than in a slow recovery. Of course the desire for the economy to collapse isn't going to have any impact on what it actually does, but you wonder about those who wish for millions to suffer so they can benefit. Of course they argue that if they own property, or invest in the economy, they should sell everything and save what they can because Armageddon is coming.
There is a difference between preparing for Armageddon and trying to make it happen.
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