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Current time:0:00Total duration:13:55

Video transcript

I think we know enough about shorting now that we can start thinking about whether it's a good or bad thing to have in financial markets what I've done here is I've drawn a hypothetical stock chart for a company this is time right here this is the price of the company and let's just say that this is a chart in a universe that doesn't have short sellers in it so this is all you know here a lot of people are buying the stock then over here some people maybe they get freaked out or whatever they start selling and then more people buy so you know demands a little higher than some then supply so there's you know the price goes up and you know you that that just generally drives the volatility now in a short selling world what would happen let me let's think about two scenarios a short seller who makes money and a short seller who loses money so a short seller making money what a short seller making money have to do if this is the stock trade obviously they don't see the stock chart beyond the day that they're actually making the trade but in order to make money they'll actually they'll have to short at the the local peaks and they would have to cover their shorts at the local minimum so good shorts are or you could even say a perfect short seller would maybe short here let me make it a different color so you can see where he's acting would short here and then cover there right and you'd make that that much money on that move and then he would wait a little bit wait for the stock to get expensive again in his mind and he was short here and then he would cover here this would kind of be obviously it's very unlikely that someone could be so well picked tops and bottoms but let's say they're just really good at their analysis and figuring out market psychology and things like that and they would just keep doing it they was short here and cover here what would that actually do to the stock right the Green Line was a reality where you had no short sellers now if you all of a sudden you allowed short selling and they had these guys coming to the market who know how to make money shorting he's shorting up here so what was shorting do shorting is you're borrowing the stock and selling it so he's creating extra supply for the stock right so what he would be doing at this point by shorting is he would actually be lowering the price at this point so let me draw the curve so there's a bunch of short sellers acting in this range it would actually lower the peak because you have a bunch you have some more aggregate sellers right so the price wouldn't go as high and then on the other hand these short sellers have to cover right here right they're going to cover their position so at the low point you have more aggregate buyers covering a short position is just you're buying the stock to pay it back because you borrowed it earlier so here you would have more aggregate buyers and then at this point once again you have more aggregate sellers so the price won't go as high you have more aggregate buyers here because the short sellers need to cover so the price won't go as low and so forth and so on and the bottom line is a short seller a short seller who is making money on the stock market so they're shorting the stock at Peaks and covering the stock at troughs is actually reducing the volatility of the stock and that's good for everybody that's good for the company's management that's good for the actual shareholders of the company and obviously it's good for the short sellers because they are they're actually making money and this is actually true for anyone making money in the stock market that they're reducing volatility what is a long just a regular investor I guess you could call them a trader since they're buying and selling a regular trader would make money by buying here and selling here buying here and selling here so really a regular trader is doing is not any different a regular long trader is no different than a short seller it's just the order in which they're buying or selling but anyone making money is buying at low points and selling at high points and anyone doing that is helping to reduce the volatility in the stock and even if you're a long term buy and hold player you would rather sit and hold a stock with my computers doing weird things you would rather be a holder of a stock that does this then a holder of a stock that does that does this now there are a lot of players both on you know you call them traders because they're buying and selling on a regular basis that aren't kind of doing this right maybe there's there they're putting their piling on the shorts at a low point and they're causing the stock to go down even more and then when the stock starts to move up they get scared and they buy it and then it causes the stock to move up even more and it increases the volatility in the stock but these guys are being penalized because they're losing money the people who sell at low points and then buy at high points and increase the volatility they're getting killed they're you know they're falling every day so it's not like you have to create some penalty for those guys their penalty is that they're just bad traders they're bad investors and they're just going to lose their shirts so if you're assuming that none of these traders in any way manipulating the markets or spreading false rumors anyone making market anyone making money in a on a stock as long as they're not manipulating it on either the short or the long side is actually a net asset for the stock that they're actually reducing the volatility of the stock price I guess another thing to think about and this is just from a you know it's good they're reducing the volatility so from that point shorting doesn't seem too bad for me or in general to the market but another way to think about it is kind of where all the incentives in the markets right who has an incentive to be positive on a stock and who has an incentive to be a negative on the stock or to scrutinize a stock scrutinize screw scrutinize alright there you go well you know the biggest I guess cheerleaders for a stock and it depends on their degree of kind of credibility or or ethics would be the company's management right these are people whoops my pen let me undo that it'd be companies management these are people who obviously run the company but they have the best transparency into the financials of a company and they tend to be shareholders of the company or get compensated based on how the stock does so these guys have every incentive to be positive and as we seen multiple examples of whether you're talking about the investment banks or Enron or Accenture they'll often kind of hide the truth when things get bad so these guys are definitely I mean big-time positive on on stocks and then let's see who are the other play are the influencers in financial markets well a big one is the financial press and I'll write it out here so we can have a discussion about whether they are pumpers of stock or whether they tend to be more whether they tend to scrutinize things a little bit more an important thing to think about with the financial press and I you know next time you watch CNBC and I don't want to just pick pick on them is you know how do they make money right do they make money by finding things that are wrong with companies do they make money by making you money or they make money by selling ads they make money by selling ads and then the next question obviously is were they selling ads to is it is it are they selling ads for mops are they selling ads for bicycles no they're selling ads for they're selling ads to to financial services companies to financial services companies financial services so people who want to manage your wealth stockbrokers mutual fund companies anyone who can advertise and this is key to because I don't know you're probably not aware of it but hedge funds can't advertise so they're not they're not consumers of the financial or they're not customers of the financial press the only people who are customers of the financial press or money managers you know financial planners and things like that brokers brokers mutual funds and all of these guys benefit when stock markets go up obviously mutual fund managers will will you know they tend to be long only so they only want things to go up stock brokers you might say oh well you know a stock broker can can advise you to go long or short and they just care about how many transactions you make but in general more and more people put money into the stock market in rising markets in a market like you're seeing right now over the last year people are pulling out pulling in you know you could say oh maybe people are doing more transactions but the general net effect is people are pulling money out of the markets so when they're pulling money out of the markets they're you know brokers are getting less transactions are managing less money and that's also true of the money managers and there's also just a you know another ancillary side effect is when market go down and people become less excited about the stock market people stop watching CNBC and you know cnnfn so and and so even those few ads that are for mops and for bicycles and for cars will get fewer viewers so in general the financial press at least in in my opinion is squarely in this camp financial press and then we can talk more you know sell side analysts you've probably heard the term sell side and by side but sell side analysts are the analysts that work for the major brokerages and investment banks who publish those reports that you you see in those ratings of by rating on IBM or whatever and the reason why they call them sell side analysts is because they work for the people who are sell essentially on some level selling you could either view them as their they often offer securities or they offer financial services to often the companies themselves or to potential acquirers of the companies or there they're selling their services I mean usually or their brokerage services so they're trying to get people to transact they're actually brokers on some level but clearly these guys their incentive since their customers tends to be the management of companies is to be very very very positive and then usually say oh well you know there are other people who would their whole job is to scrutinize these people like the government but if you think about it once again the government likes a rising stock market it takes you know when people's 401ks are rising it you know the economy does better the government doesn't have to worry as much about social you know other types of social benefits and unemployment and things like that so in general and and if you want to be more I guess if you want to be more critical of the government you could also say that there to some degree they're very close to the management of these firms and to financial companies and to some degree these guys have significant clout in terms of lobbyists and well actually I would even say the bankers to their significant clout in terms of lobbying and and just an access to government generally and you know government drives the regulator's so these guys are also on the positive camp and then finally have the ratings agencies and the ratings agencies mainly operate in the debt world and we'll talk more about that but if you can scrutinize a company on the debt level and you say oh wow you know this company really isn't that good they're not going to be able to pay off its debt that kills the stock right but once again you have to realize that the rating agencies are also paid by the bankers so the rating agencies are also have the incentive to kind of not see things when things are bad so out of every one of the financial services or the financial world that we've talked about right now they all benefit when stocks continue to go up even when they go up beyond what they really should go up and even if they all kind of know that things are a little bit too expensive or this management team might be a little shady or they might be covering up something none of these people really have an incentive to expose it and the only people who do are the short sellers these are the only people who really have you know arguably the sophistication and the time and the monetary incentive to really look and scrutinize what management is doing to really look in the books and kind of put a pup you know put a put a puzzle together or put a bunch of pieces together to come to a conclusion wait you know the numbers the management is pouting really don't add up and because of XY and Z this company really is overvalued so on to a large degree they are kind of on on Society side in preventing management from kind of being overly bullish and I don't want to sound like someone who just broadly is defending short sellers there is a class of short sellers that I think would be bad and that's the people who are spreading false rumors and being market manipulators so there's this a general you know market manipulation manipulation market manipulation or you know rumor mongering and that definitely is bad and to some degree if you can show someone is doing that there should be some type of penalty for doing it but even there you know just in my experience participating in public markets if I had to pick you know if I had to pick between the left side of that chart between this side of this chart and this side of this chart and if I had to say who does who does spread false information when it does get spread I think oftentimes management is a little bit more guilty of it than the short sellers in fact there's very few times that I've seen where the short sellers are you know there's some negative thesis on the stock and where it really comes out to be completely untrue although you know there are examples and those short sellers you know I don't think are are really in the mainstream anyway I don't want to meander too much I realize that this video has already gotten long but I thought it's a it's a nice useful discussion to maybe think a little bit about whether short selling really is all that bad even if you are a long investor