Why most short sellers lose money
New moves to curb short selling in some countries have paved the way for a renewed struggle between free market advocates and authorities to screen investors they perceive as speculators destabilizing large companies..
Turkish regulator banned short sales to seven domestic banks last month after US prosecutors accused state lender Halkbank of violating Iranian sanctions.
South Korea is considering the restrictions while European authorities are investigating unscrupulous sellers over alleged market manipulation – part of an emerging trend that Carson Block, founder of US short-selling Muddy Waters Capital LLC, told Reuters in a comment «global war against truth».
Meanwhile, as Brexit emerges, authorities in Frankfurt, Rome and Amsterdam may temporarily restrict short-selling of companies’ shares to counteract price fluctuations caused by the European divorce, officials told Reuters..
The effectiveness of such bans has been questioned by some academics and regulators, including the Federal Reserve Bank of New York. But global sentiment can turn against short sellers who borrow stock and sell it right away, betting that the price will fall before they buy back the stock and get it back, narrowing the gap..
Brexit and the US-China trade war are among the political and macroeconomic forces that are hitting markets, creating new puzzles for regulators. For example, South Korean officials cited the trade conflict as the reason for the possible restriction of short selling..
Such bans have been significantly reduced since 2008-2012, when the authorities moved to support falling markets during the global financial and European debt crises..
«While short selling can be a valid trading strategy, using it in conjunction with spreading false market rumors is clearly wrong.», – stated by the European Securities and Markets Authority (ESMA) in 2011 when short selling bans swept Europe.
The EU agency said countries have introduced bans to limit the benefits of spreading false rumors or to achieve a regulatory level of the playing field.
Critics of the bans, however, say the restrictions undermine free markets as well as impede accurate asset pricing and reduce trading volumes, raising transaction costs for all investors..
Richard Payne, professor at the London Business School Cass, said research shows that «the real effect of these bans is simply to increase trading costs and reduce trading activity».
For example, a New York Fed analysis of more than 400 US stocks in 14 days, during which short-selling bans were introduced at the end of 2008, showed that they did not have the expected effect..
During this period, the average price of these shares decreased by 12%, mainly in line with non-financial shares, which are not subject to restrictions. Meanwhile, according to a 2012 report, the trading costs of these stocks are up more than $ 600 million from the average..
«Our analysis … suggests that the bans had little effect on stock prices, analysts write, admitting that the specific reasons for price movements were unclear. – At the same time, bans have reduced market liquidity and increased trading costs».
An analysis of ESMA’s short selling bans in 2017 also showed that there was no statistically significant impact on stock prices or liquidity..
The EU agency, however, remains committed to the choice of regulatory measures. This year, she backed a two-month ban on the sale of payment firm Wirecard in Germany after media reports of financial irregularities like «appropriate and proportionate to eliminate the threat to the German financial markets».
Fabio De Masi, a left-wing German politician, told Reuters that short-selling bans can be legitimate tools for dealing with traders looking for unfair profits and can cause panic in the market, even if their effectiveness may vary..
He questioned the value of short selling altogether and said hedge funds should be regulated.. «Not every financial player or innovation benefits our economy», – he added.
The Turkish ban initially pushed up banking stocks, fueled by broader market growth. Although trading volumes fell to their lowest level in a year in the following days, they have since begun to approach levels prior to the ban..
Financial regulators in Germany and France declined to comment for this story. Borsa Istanbul, Turkish Stock Exchange and Financial Supervisor, did not respond to a request for comment.
Bans on short selling are not recent market phenomena; they have roots in the early 1600s when the authorities intervened to prop up shares in the Dutch East India Company.
Some critics, such as Block of Muddy Waters, see bans and other action against the shorts as part of a wider political game..
«Constraints are a way to codify the term fake news, which really means “true but inconvenient news”», – said Block.
He added that after Germany and France launched an investigation into short sellers, he hesitated to speak publicly about his short positions in both countries..
State prosecutors in Germany, France and Italy have investigated short sellers who were betting against Wirecard, French retailer Casino and Italian bioplastics manufacturer Bio-on.
Dan David, another American short-seller known for betting against Chinese companies, said he fears similar action by global regulators in the event of a recession..
«Such intervention never works in the long term, but never produces political results in the short term.», – he added.
Khaled Abdel Majid, founder of London-based hedge fund firm Mena Capital, said the Turkish ban is a sign of economic weakness and that it tends to stay out of the country..
«Any country trying to influence the market by passing new laws is not a good sign.», – he said.
Kerr Neilson, founder of Platinum Asset Management’s $ 17 billion global equity investor, said the move away from global free trade norms is accelerating, which could include more government action against short sellers.
«We live in a world of intervention», – he said.