I’m now learning about stock markets and my question is this: when short sellers sell, who buys?
Whoever wants to buy at the price they are selling at.
Yeah, but who would? It seems like the people who want to get rid of those stocks do it for a pretty good reason (it is no longer profitable to have them), so very few bad stocks should find buyers.
I played around a little with forex trading software, and you could just press “sell” instantly, like there was always someone willing to buy.
Doesn’t this mean the stock exchange is a zero-sum-game, where some people win by playing it smart at the expense of others?
Perhaps market makers are somehow involved? They set a sort of price floor and ceiling, and guarantee a certain amount of stocks are bought/sold?
Actually if anyone has a link to an article concerning market makers and the function and legitimacy of their work, it would be greatly appreciated.
Buyers do. A short sell to the buyer is just a sell. The buyer gets any dividends on the equity. The brokerage house supposedly guarantees (Or the Federal Reserve Decreases the Value of the Currency Stock) that the short seller will be able to cover the money to buy the stock back if it does not behave as the short sell wishes.
DO NOT BE FOOLED BY THE LIARS, CHEATS and PROPANGISTS about the bad effects of short selling. Equities and other investments go through Short Squeezes all the time as too many people short the stock. The LIARS, CHEATS and PROPANGISTS are just mad that the short sellers grab any money left in the equity before management has a chance to steal it.
Think about short selling as a kind of insurance. If you are a farmer and the harvest is 3 months away, you could offer to sell that harvest in 3 months at the current price. That way, you would have a insured yourself against falling prices but, on the other hand you have given up the oportunity to gain from rising prices. This is the classical short seller. Now consider you are a miller, and you want to be able to calculate how much you need to charge for a pound of wheat in 4 months. It would be good to know what price you can buy the grain in 4 months, or at the next harvest. Buy agreeing to the farmer to buy the grain at harvest time at todays price, you are protected against any rise in price and you can do your calculatiion on a much sounder basis. In that case you are the one that is the buyer of a short sell.
This was the initial idea of short selling and it is used much more than the gambling where people just bet on prices like they bet on horses. Pension funds for example are a big community that sell short and long to minimize the risk involved in ther stock engagements. This is called hedging.
I hope you’re not suggesting that gambling or betting on horses is somehow less worth than the ability to hedge risk.
Short selling is not gambling in any sence. In the sence that the short sellers steal the remaining equity in poorly run companies this is true gaming as they get to take revenue left in the equity before the managers and bond holders have a chance to steal it. If it wasn’t for short sellers the managers of Freddie and Fannie would have stolen millions through the misleading financial reports and what not. THink of any poor folks considering buying one of these stocks. The short sellers made this decision stupid.
Also short selling conveys critical information to other investors. For example: I purchased WM at $35 per share only to find it at $3 per share some months later. Had the short sellers kicked in earlier I would probably not have purchased the stock.
Not at all. I just wanted to show that there are more good reasons for shorting than specualting, which is a very useful and valid approach in itself.
I do not think it is useful to say that shortselling or long selling is not gambling in any sense. It could be and no one can know if your reason for going short is based on a guts feeling or based on whatever rationalisation you want to put on it. Noone can decide if someone elses decission is good or bad anyway.
I am a strong supporter for letting all economic activity go unhampered. And I absolutly agree that short sellers in general provide important information to the market as a whole, as last weeks events have proved. Those short sellers where right, weren’t they?
I was playing with forex and futures trading platforms too, and I was trying to understand the workings behind that, I came to follwing conclussion:
As regards time limited trades where you keep your position just for a limited time, for every closed position there will be the buyer and seller, buyer was anticipating increase while seller decrease, one of them must loose while other is winner. Sure winner is here just market maker who cashed in the spread. This is the case of forex and futures tradning.
Forex and future trading is mostly gambling, mathematically the price curve is sort of chaotic system, exhibits trends, but start and and of trend is random.
Forex and futures trading might server the purpose, it might the tool to lock in current price and thus hedge agiant the unpredictable price movements.
As regards shares, people often use it as investment tool, they buy shares believeing that price of stocks will raise if economy doing well. The stocks do not serve its original purpose anymore, that is to say they are not used as tool how investor can get its own share on compannies assets and cash his/her profit in the form of dividend. Overall stocks became the speculation, stock buyers are believers in the price increase of share.
Forex, future and stock markets became mostly speculation then the tool helping the companies to acquire new capital. In true free-market economy without goverment protectionism and regulation they would never evolve into today’s monstrous size so prone to the panic.
If I ever have money I invest in prescious metals or buy land.
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People get into Foreign Exchange and the Stock Market because they want to make money, not because the stuff they buy have a value in itself. You don’t buy Google stock like you’d buy milk, just for the sake of the stock. You buy it because you hope it will worth more in the future. You sell it to get rid of it and hope someone else will take the fall when you think the stock will devalue.
Doesn’t this make forex or the stockmarket a zero-sum-game?
Also, how is a company affected by fluctuations in it’s stock price?
As I have pointed out elsewhere I’m not an economist, nor an investor, nor is english my main language. As such, I need to define how I understand the terms short selling, zero-sum-game, forex before answering your questions. Thus if you find anything wrong in my definitions you can just ignore my answers. I’m sorry if it seems too trivial.
Short selling is an act where an entity, B, borrows an asset (stock, commodity etc.) from entity, A, with a promise to return the asset at the end of a given period. Expecting the value of the asset to fall, B, sells the asset to entity, C, with a promise to buy back the asset at a later date. Thus, at the time of repurchase, B, will again be in possesion of the asset and can uphold its original promise to return the asset to, A.
Zero-sum-game is a game in which participants can only recieve a share from a predefined pool of “winnings” at the end of the game. Thus whenever one participant somehow increases his/her share it can only come by as a result of another participants share being decreased.
Forex, i.e. foreign exchange, is the exchange of one currency for another. (Nothing more to it I hope?)
Now, returning to you questions. In your original post you asked about short selling and stock markets. In subsequent posts you mention forex. However, I think you are doing yourself a disservice by mixing these together. As I understand things there is the Future Market, the Stock Market, the Foreign Exchange Market, the Commodity Market etc. (Obviously there is more of each, but I’m just sticking to general terms). In consideration of my definition above, I consider short selling to be strictly connected with the Future Market. (If not, then what is there to be unsure about?). Thus what you are asking about is, in short, this:
- Is the Future Market a zero-sum-game?
Now, of course there are Future Markets dealing in either stocks, currencies? or commodities. This amounts to saying that the objects of the Future Market can be anyone of these “assets”. But you need to keep in mind that the Future Market runs parallel to the conventional markets of each kind of asset. These conventional markets are what sets the value of the assets; also, they deal in the ownership of assets - the Future Market does not (as I understand it at least). Thus if you follow a chart depicting the ongoing evaluation of the ownership of any of these assets, in any given period of time, and integrate the resulting curve, you end up with either a net loss or net gain for the period. So, e.g. if you scope is always a time-period of, say, 3 months, you cannot ex ante be sure whether at the end of the time-period the result will be a net loss or net gain, in the evaluation of whatever asset in question, compared to the value at the beginning of the time-period. You can, however, ex ante, bet against it being a net loss or net gain. In fact, no one can be sure, and If no one can be sure, how can it be a zero-sum-game? Where, B, might think it to be a net loss, C, might end up being right about his/her bet that it is a net gain.
If not, well, then obviously, as the time of repurchase comes nearer, C, might change his/her mind and sell it on to, D, to “cover his losses”. But this does in no way prevent D from profiting at the end. Remember the conventional markets dealing in ownership of assets, running in parallel to the Future Market, might suddenly change the evaluation of whatever asset B, C, and D are betting on. Thus right after, D, has taken over from, C, the evalution might increase drastically thus allowing, D, to profit, when, C, in upholding the promise to buy back the asset at a premium, looses more than he would have if he had not passed it on to, D. In this case, D, has not gained by, C, loosing a part of his share of the pool of “winnings” to, D. Of course, superficially, you could say he has, but that is an ex post consideration, not ex ante. If this was the way to measure the game, well then the notion of the free market being a plus-sum-game wouldn’t sit right with you either I suspect. No offence!
I hope this has clarified things a bit for you. It has for me at least [;)]
- What is the point of the Future Market then, you might ask?
I’m not entirely sure myself, but if I’m right in my definition of short selling I suppose it is a way to not be encumbered by ownership when investing. E.g. investing in a commodity can be cumbersome if you have no way to store it, which I found out when considering to invest in gold.
In regards to you question about how a company is affected by its stock price, I would ask you to qualify you question a little, because my immediate answer would be: It depends!
If the company has bought back its stock (this is not uncommon I find) whereby it is part of the company’s equity* then it will have an effect in regards to its use as collateral when borrowing funds to finance its operations. Now, if a company does not own its own stock then, in a sense, it can just ignore the stock price. However, seeing as the stock price is valued in regards to a company’s ability to pay future dividends etc. how would you feel about working for a company whose stock price is plummeting for instance? or being its creditor? How would you be sure to be payed a wage or principal + interest?
*) I hope my usage of equity is right in this case. I’m thinking about the part of a company’s liabilities that is not owed to creditors.
NB I’m sorry for the amount of anthropomorphism in this reply. I do not intend to imply that markets or companies act, per say, but this has merely been the easiest way for me to answer you questions.
Theoretically, successful companies and speculators are rewarded. The money for those rewards comes from people who make bad bets. So, in a sense, it is a zero-sum-game, except that a consequence of this game is that resources end up in the hands of people who are good at managing/planning/forecasting, etc.
(The stock market may be a zero-sum-game but the market itself and division of labor are not.)
Even among people who ought to know better, there is a presumption that stock speculation is a zero-sum game, and that if one person buys low and sells high, his gain only comes at the expense of someone else, leaving society on net exactly the same.
Speculators Correct False Prices
Speculators are out to make money, to buy low and sell high, as the cliché goes. What this truism entails, however, is that the successful speculator — who can consistently buy low and sell high — can predict certain stock prices better than others, and indeed even better than others who are risking money on those very stocks. For example, if a speculator buys at $100 on Monday and sells at $110 on Friday, he was only able to do this because other people in this very market didn’t realize on Monday that the stock would appreciate so quickly. (If they did, they wouldn’t have sold for $100. They would have held onto the stocks and netted the gain themselves.)[1]
If this were the whole story, then stock speculation might truly be a zero-sum game, where the lucky or farsighted enrich themselves at the expense of the unlucky or dimwitted. This isn’t the case, however, because in the very process of profiting from their superior vision, stock speculators influence stock prices. When stock prices are undervalued, the successful speculator buys shares, an action that drives up the prices in question. In contrast, if a stock is “overvalued” — and by this term we mean nothing deeper than that the stock will fall in price more quickly than others in the market realize — then the successful speculator may “short sell” it, or engage in comparable actions (such as buying a put option) that tend to push down the share price.
In the aggregate, we have thousands or even millions of professionals who study the stock market from every conceivable angle, looking at both political events and fundamental data on individual companies. Consequently, new information is quickly incorporated into expectations and finds its expression in updated stock prices. Although some Chicago economists — as is their wont — take this notion of the “efficient (stock) market” too far, it is certainly true that individual efforts to make a buck foster a mind-boggling nexus of analysis and communication.
“Oh, what’s this? North Korea just tested a nuclear device? What are the implications for the share price of IBM?” I don’t know, and neither does anybody else — no one could possibly grasp all of the information relevant to this question. Even so, individuals who believe they have a better handle on this question than most others can put their money on the line by buying (or shorting) IBM stock, and waiting for events to bear out their minority view. There is no guarantee, of course, that the current crop of capitalists will make the right forecasts, but as with every other occupation here too the free market does an excellent job of pruning: people who repeatedly make erroneous bets in the stock market lose all of their money and can no longer disrupt share prices. Over time, those with the most influence on the stock market are the ones who best predicted its movements in the past.
Shorting, or short selling - the process of borrowing stock to sell and then buy back at a lower price - gives day traders a way to make money when prices are falling. That means double the potential number of trades available, a huge benefit. There are other advantages to being able to go short. short selling is still an essential weapon in the traders armoury. Without it, there would be some days when there are simply no profitable trades to be made. Having the ability to profit from rising and falling markets means traders can profit every day the markets are open.