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Can anyone explain what utility, to the real economy, that short selling stocks provides? Practically speaking, why is shorting useful? What problems in the fin

Can anyone explain what utility, to the real economy, that short selling stocks provides? Practically speaking, why is shorting useful? What problems in the financial system does it solve. Asking in earnest.

nradov 6y ago
Short selling accelerates price discovery in order to allow for more efficient capital allocation, thus making our overall economy stronger.
- criddell 6y ago
  > more efficient capital allocation Can you explain this more? More efficient on what axes? How does that translate to societal benefits that aren't just on paper?
  - FabHK 6y ago
    Ok, here are the links: * When a firm decides whether to take on new projects, they look at the projected profit of that project, and compare to their cost of capital. Only projects whose profit exceeds the cost of capital should be executed. * Stock prices influences a firm's cost of capital, eg when raising more money. * Relative stock prices also influence, in mergers, say, who takes over whom. * Via all these levers and more, stock prices help select which projects of all possible ventures are realised, and who manages them. * All of this is aimed at funding those projects that produce the highest output relative to the resources dedicated to them. * All of this only works if stock prices are a somewhat accurate reflection of the prospects of a firm; in other words, if the share price reflects the fundamental value of the firm. * Short sellers (and long buyers) that analyse firms and trade when they perceive a discrepancy between share price and fundamental value can trade upon that insight, which will have two effects: a) it will tend to bring the share price closer to the fundamental value, and b) it will be profitable for the firms that are correct in their assessment. That's basically the big picture story.
  - milesvp 6y ago
    There’s a better answer in this thread, but a tl;dr/eli5, is that if all I can do is buy a stock then the only information available in the price are the people who believe in the stock/bond (usually as a proxy for belief in the company). This means that all the people who believe the stock/bond is no good have no way to lend their belief to the price of the stock/bond. This represents an optimistic asymmetry in the stock/bond price. By having the ability to short, some of the asymmetry is removed thus making the price better able to reflect the future expected value of stock/bond. That’s what makes it “more efficient”.
- snarf21 6y ago
  Agreed, but something is only worth what someone is willing to pay for it. They shouldn't be crying now when other add increased price pressure.
- mdoms 6y ago
  lol come on
skrebbel 6y ago
It's in a short seller's interest to get a company negatively in the media. This means that they will actively hunt for morally/legally/financially objectionable stunts a company might pull and leak it to journalists. There's a lot of fun Matt Levine articles on Bloomberg about this dynamic. Eg from https://www.bloomberg.com/opinion/articles/2020-05-29/you-can-pay-credit-suisse-not-to-work-there https://www.bloomberg.com/opinion/articles/2020-05-29/you-ca... (https://outline.com/atF74W https://outline.com/atF74W): > The thing about inflating your revenue by pretending that you sold more coffee than you did is that people can go to your stores and watch you sell coffee. It is a reasonable bet that they won’t do that, because it’s incredibly boring. “Who is going to send 1,500 people to our stores to watch us sell coffee all day, count how much we sell and compare it to our financial statements,” Luckin could reasonably have thought. But the answer was “short sellers”! They actually hired people to sit around watching the coffee get made, so they caught the fraud. I also warmly recommend his "Everything is securities fraud" rant that follows this paragraph. (note: I know nothing about stock markets (or reddit or gamestop for that matter) so someone let me know if I'm just a noob eating up some slightly smarter noob's nonsense)
scatters 6y ago
Short selling incentivizes fraud investigation. Case in point: Muddy Waters.
matthewbauer 6y ago
In theory, it can lessen volatility since traders can bet against overvalued companies in the same way they can invest in undervalued companies. In practice, I'm not so sure if this is really how short selling works, since "the market can remain irrational longer than you can remain solvent". I do think a world without any short selling would have much more frenzied boom / bust cycles though.

nradov 6y ago

Short selling accelerates price discovery in order to allow for more efficient capital allocation, thus making our overall economy stronger.

criddell 6y ago
> more efficient capital allocation Can you explain this more? More efficient on what axes? How does that translate to societal benefits that aren't just on paper?
- FabHK 6y ago
  Ok, here are the links: * When a firm decides whether to take on new projects, they look at the projected profit of that project, and compare to their cost of capital. Only projects whose profit exceeds the cost of capital should be executed. * Stock prices influences a firm's cost of capital, eg when raising more money. * Relative stock prices also influence, in mergers, say, who takes over whom. * Via all these levers and more, stock prices help select which projects of all possible ventures are realised, and who manages them. * All of this is aimed at funding those projects that produce the highest output relative to the resources dedicated to them. * All of this only works if stock prices are a somewhat accurate reflection of the prospects of a firm; in other words, if the share price reflects the fundamental value of the firm. * Short sellers (and long buyers) that analyse firms and trade when they perceive a discrepancy between share price and fundamental value can trade upon that insight, which will have two effects: a) it will tend to bring the share price closer to the fundamental value, and b) it will be profitable for the firms that are correct in their assessment. That's basically the big picture story.
- milesvp 6y ago
  There’s a better answer in this thread, but a tl;dr/eli5, is that if all I can do is buy a stock then the only information available in the price are the people who believe in the stock/bond (usually as a proxy for belief in the company). This means that all the people who believe the stock/bond is no good have no way to lend their belief to the price of the stock/bond. This represents an optimistic asymmetry in the stock/bond price. By having the ability to short, some of the asymmetry is removed thus making the price better able to reflect the future expected value of stock/bond. That’s what makes it “more efficient”.
snarf21 6y ago
Agreed, but something is only worth what someone is willing to pay for it. They shouldn't be crying now when other add increased price pressure.
mdoms 6y ago
lol come on

skrebbel 6y ago

It's in a short seller's interest to get a company negatively in the media. This means that they will actively hunt for morally/legally/financially objectionable stunts a company might pull and leak it to journalists. There's a lot of fun Matt Levine articles on Bloomberg about this dynamic. Eg from https://www.bloomberg.com/opinion/articles/2020-05-29/you-can-pay-credit-suisse-not-to-work-there https://www.bloomberg.com/opinion/articles/2020-05-29/you-ca... (https://outline.com/atF74W https://outline.com/atF74W): > The thing about inflating your revenue by pretending that you sold more coffee than you did is that people can go to your stores and watch you sell coffee. It is a reasonable bet that they won’t do that, because it’s incredibly boring. “Who is going to send 1,500 people to our stores to watch us sell coffee all day, count how much we sell and compare it to our financial statements,” Luckin could reasonably have thought. But the answer was “short sellers”! They actually hired people to sit around watching the coffee get made, so they caught the fraud. I also warmly recommend his "Everything is securities fraud" rant that follows this paragraph. (note: I know nothing about stock markets (or reddit or gamestop for that matter) so someone let me know if I'm just a noob eating up some slightly smarter noob's nonsense)

scatters 6y ago

Short selling incentivizes fraud investigation. Case in point: Muddy Waters.

matthewbauer 6y ago

In theory, it can lessen volatility since traders can bet against overvalued companies in the same way they can invest in undervalued companies. In practice, I'm not so sure if this is really how short selling works, since "the market can remain irrational longer than you can remain solvent". I do think a world without any short selling would have much more frenzied boom / bust cycles though.