| In finance, short selling or "shorting"
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| | contribution to stock market efficiency.
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| is a way to profit from the decline in
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| | Moreover, less than 5% of all shorts are
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| price of a security, such as stock or a
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| | done by public investors and traders,
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| bond. Most investors "go long" on an
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| | whereas at least 95% of short sales are
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| investment, hoping that price will rise.
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| | done by broker-dealers and market makers
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| To profit from the stock price going
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| | who do not even always have to own shares
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| down, a short seller can borrow a
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| | to sell them (this is called naked short
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| security and sell it, expecting that it
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| | selling).
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| will decrease in value so that they can
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| | The term "short" was in use from at least
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| buy it back at a lower price and keep the
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| | the mid-19th century. It is commonly
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| difference. For example, assume that
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| | understood that "short" is used because
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| shares in XYZ Company currently sell for
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| | the short seller is in a deficit position
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| $10 per share. A short seller would
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| | with his brokerage house.
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| borrow 100 shares of XYZ Company, and
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| | Short sellers were blamed (probably
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| then immediately sell those shares for a
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| | erroneously) for the Wall Street Crash of
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| total of $1000. If the price of XYZ
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| | 1929. Regulations governing short selling
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| shares later falls to $8 per share, the
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| | were implemented in 1929 and in 1940.
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| short seller would then buy 100 shares
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| | Political fallout from the 1929 crash led
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| back for $800, return the shares to their
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| | Congress to enact a law banning short
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| original owner, and make a $200 profit.
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| | sellers from selling shares during a
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| This practice has the potential for an
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| | sharp downturn. President Hoover
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| unlimited loss, for example, if the
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| | condemned short sellers and even J. Edgar
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| shares of XYZ that one borrowed and sold
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| | Hoover said he would investigate short
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| in fact went up to $25, the short seller
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| | sellers for their role in prolonging the
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| would have to buy back all the shares at
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| | Depression. Legislation introduced in
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| $2500, losing $1500.
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| | 1940 banned mutual funds from short
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| However, the term "short selling" or
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| | selling (this law was lifted in 1997).
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| "being short" is often used as a blanket
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| | Some typical examples of mass
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| term for all those strategies which allow
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| | short-selling activity are during
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| an investor to gain from the decline in
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| | "bubbles", such as the Internet bubble.
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| price of a security. Those strategies
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| | At such periods, short-sellers sell
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| include buying options known as puts. In
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| | hoping for a market correction. Food and
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| fact, what is many times labeled short
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| | Drug Administration (FDA) announcements
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| selling is options or futures activity,
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| | approving a drug often cause the market
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| since this activity greatly magnifies the
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| | to react illogically due to media
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| gain that results from a securities price
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| | attention; short sellers use the
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| loss. For example, if the next earnings
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| | opportunity to sell into the buying
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| release of XYZ company is going to show
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| | frenzy and wait for the exaggerated
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| that its profits declined somewhat in
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| | reaction to subside before covering their
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| some of its divisions, its stock might
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| | position. Negative news, such as
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| decline only 5 percent when that
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| | litigation against a company will also
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| information is released. Someone within
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| | entice professional traders to sell the
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| the company who wants to trade in inside
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| | stock short.
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| information however would probably not be
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| | Short selling stock consists of the
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| satisifed with only a 5 percent gain on
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| | following:
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| his short sell and instead would buy put
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| | An investor borrows shares, but since
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| options or other derivatives or futures
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| | there is a general rule in the United
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| to gain possibly 20 or more percent on
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| | States that one must only borrow money
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| the decline in the stock price of XYZ.
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| | based on shares up to 50 percent of the
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| Short selling has been a target of ire
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| | shares' value, one must deposit 50
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| since at least the 18th century when
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| | percent of the value of the shares in
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| England banned it outright. It was also
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| | cash with one's brokerage firm.
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| considered a disreputable business
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| | The investor sells them and the proceeds
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| practice because of the perceived
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| | are credited to his account at the
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| magnifying effect it had on the violent
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| | brokerage firm.
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| downturn in the Dutch tulip market in the
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| | The investor must "close" the position by
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| 17th century. Short sellers are widely
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| | buying back the shares (called covering)
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| regarded with suspicion because, to many
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| | - If the price drops, he makes a profit.
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| people, they are profiting from the
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| | Otherwise he makes a loss.
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| misfortune of others. However, academic
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| | The investor finally returns the shares
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| studies have generally lauded
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| | to the lender.
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| short-selling as an important
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