I understand that a lot of speculative financial activity can be useful. Longing speculation makes it easier for primary market stockholders to move out of their positions which means they’ll be more likely to invest which means that more capital can be allocated and that it will be allocated to the most productive activities. Hedging allows businesses to protect themselves against price variations which makes planning easier. We have here another example of private and social interests being broadly aligned when it comes to the provision of rival and excludable goods.
But, aside from the fact that the short seller or the person permitting the stock to be short sold can make money, what’s the benefit to society at large?
Is there a difference between naked shorting and non-naked shorting when it comes to social benefits?
The former is useful as the price of an asset serves as a signal - that’s the entire point of a price, actually. The latter is useful as it allows more efficient and rapid allocation of capital due to decreased transaction costs and lessened uncertainties - the great advantage of capitalism.
I would go further and say that the two reasons you’ve offered why buying forward is beneficial - liquidity and risk management - also apply equally to selling forward. They are two sides of the same transaction.
Also worth noting (although I’m sure you already realise this) that the person taking a short position is no more likely to gain than the person taking a long position.
A very large part of it is that people think it’s profiting from misery…
The other problem is in a disorderly market the market can easily get distorted from panic selling; that, it is felt, will only be exacerbated by permitting opening of short positions.
In theory to mitigate the above
Yup. Think of any order as being somewhere on the spectrum between demanding liquidity and supplying liquidity. Those supplying liquidity need flexibility both to be able to do so in the first place (if they’re flat, how are they going to quote you an offer?) and to be able to quote at prices at least approaching fair value.
Market makers are usually exempt from short selling bans of any kind, for this reason.
Course when it all goes tits up in the more liquid exchange traded instruments, traditional market makers have pretty much gone; a large part of that is now operated unofficially by hedge funds, black boxes at IB prop desks, whatever… who will disappear whenever things get more volatile and they’re actually most needed. Brave new world…
In physical assets you have to allow for the cost of carry. Apart from that, if there was a systematic advantage to taking a short position, I presume it would either be arbitraged out or (more simply) the market price would adjust to remove the advantage and equalise the expected value. Otherwise, why would anyone agree to buy?
