5. Shorting Stocks

Why It’s Important to Be Able to Short Stocks

To many investors (and some electric car CEOs), short sellers are just the worst. They push down stock prices and profit off the misery of others. But short sellers do serve a few important purposes.

For starters, they have a tendency to root out fraud and misconduct – a sentiment Warren Buffett admitted to sharing in a 2006 Berkshire Hathaway shareholders meeting.

Additionally, short sellers provide demand for shares and enhance market liquidity. Buffett had no issues with investors who sold Berkshire Hathaway short since they eventually had to buy the shares to cover.

When shorts misfire, they have to buy back the stock quickly in order to prevent deeper losses. Since stock prices don’t have ceilings, losses from short sales can exceed the initial cost of the investment.

When short sellers scramble to cover, it creates a cycle where more short sellers are forced to cover to prevent massive losses – this is called a ‘short squeeze’. Short squeezes cause stock prices to rise rapidly as the market for sellers dries up and upward pressure multiplies. 

Leave a Reply

Your email address will not be published. Required fields are marked *