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Hi, former hedge fund portfolio manager here (for 13 years). First, companies with strong fundamentals and short term liquidity issues rarely go bankrupt, beca

Hi, former hedge fund portfolio manager here (for 13 years). First, companies with strong fundamentals and short term liquidity issues rarely go bankrupt, because there are plenty of entities willing to lend them money to smooth out their cash demands. This is basically the entire reason that commercial lines of credit exist. Second, believe it or not companies can go bankrupt without wiping out their stock price. Bankruptcy courts are smart enough to not give away the entire company to the debtors when they owe $1 today but will receive $2 tomorrow. Third, attempting to actively drive down a stock’s price with short sales is a pretty bad strategy. First of all, the Downtick Rule is a thing that exists. Second of all, and more importantly, if the stock is illiquid enough that (Downtick Rule notwithstanding) a short-seller can manipulate the price downward, that means the stock is illiquid enough to manipulate in the other direction when a buyer decides to execute the same strategy in reverse (and buyers have no stock borrow requirement and no equivalent to the Downtick Rule to worry about - you can absolutely drive up stock prices perfectly legally, provided that act isn’t part of some other illegal scheme like a pump and dump). Finally, the discussion around short selling almost always focuses on a few high profile speculators and never acknowledges that the vast majority of shorting is for passive hedging (e.g. of options trades) where the “desired outcome” of the short seller probably isn’t for the price to fall. E.g. if you buy a call option and hedge the delta by shorting stock, you are indifferent to whether the stock goes up or down - you are betting on volatility, not price movement. Think about it this way: if short selling were the act that it is often made out to be we would see every stock driven to zero by these all-powerful short sellers. We don’t, because short sellers don’t have the power people think they do and also aren’t (mostly) interested in seeing prices fall.

AnthonyMouse 5y ago
> First, companies with strong fundamentals and short term liquidity issues rarely go bankrupt, because there are plenty of entities willing to lend them money to smooth out their cash demands. This is basically the entire reason that commercial lines of credit exist. A company in a precarious position has trouble finding new creditors. Not many banks will give you a loan if there is only a 50% chance you'll be able to pay it back. > Second, believe it or not companies can go bankrupt without wiping out their stock price. Bankruptcy courts are smart enough to not give away the entire company to the debtors when they are short $1 today but will receive $2 tomorrow. Failure to raise capital can make a company worthless when it wouldn't be otherwise. You have customers willing to buy products but no equipment to make products, so without capital the customer demand can't be turned into money. But customer demand can't be sold to a competitor in bankruptcy court. > Second of all, and more importantly, if the stock is illiquid enough that (Downtick Rule notwithstanding) a short-seller can manipulate the price downward, that means the stock is illiquid enough to manipulate in the other direction when a buyer decides to execute the same strategy in reverse (and buyers have no stock borrow requirement and no equivalent to the Downtick Rule to worry about - you can absolutely drive up stock prices perfectly legally, provided that act isn’t part of some other illegal scheme like a pump and dump). But then how does the buyer make money? They buy a ton of stock of a company that still might go out of business. It's less likely to go out of business that way, but you don't get to find that out for another year, and it's not so much less likely that this strategy would have the same level of profit as short selling a company that then goes to zero right away because they couldn't raise the capital immediately required to continue operations. > Think about it this way: if short selling were the act that it is often made out to be we would see every stock driven to zero by these all-powerful short sellers. You can't just go short Apple and expect it to drive them out of business. It only works for a company which is already at risk, to push them over the precipice. And it's a high risk strategy. If you fail to drive them out of business you could lose a lot of money. But if you succeed, you make a lot of money at the expense of the people who lose it to you.
- peterbonney 5y ago
  > But then how does the buyer make money? They buy a ton of stock of a company that still might go out of business. But then how does the short-seller make money? They short a ton of stock of a company that still might not go out of business. See how it works both ways? As for everything else, I don’t know what to tell you - there is no basis in reality for your extremely narrow hypothetical construction, so there is nothing to argue with. As someone with some expertise in finance and investing I am telling you that you don’t understand what you are talking about, and I don’t mean that in an insulting way - this is complicated stuff. You can choose to ignore me as an a-hole on the internet, or you can choose to take the feedback and accept that there is more for you to learn on this subject before you offer opinions. It’s entirely your call.
- pyuser583 5y ago
  If a company only has a 50% of paying back a loan, there's more going on the a cash flow problem.
pyuser583 5y ago
My understanding is that short selling is basically a type of insurance. Is that correct?
GlennS 5y ago
Thanks for this explanation. I found it really useful.

AnthonyMouse 5y ago

> First, companies with strong fundamentals and short term liquidity issues rarely go bankrupt, because there are plenty of entities willing to lend them money to smooth out their cash demands. This is basically the entire reason that commercial lines of credit exist. A company in a precarious position has trouble finding new creditors. Not many banks will give you a loan if there is only a 50% chance you'll be able to pay it back. > Second, believe it or not companies can go bankrupt without wiping out their stock price. Bankruptcy courts are smart enough to not give away the entire company to the debtors when they are short $1 today but will receive $2 tomorrow. Failure to raise capital can make a company worthless when it wouldn't be otherwise. You have customers willing to buy products but no equipment to make products, so without capital the customer demand can't be turned into money. But customer demand can't be sold to a competitor in bankruptcy court. > Second of all, and more importantly, if the stock is illiquid enough that (Downtick Rule notwithstanding) a short-seller can manipulate the price downward, that means the stock is illiquid enough to manipulate in the other direction when a buyer decides to execute the same strategy in reverse (and buyers have no stock borrow requirement and no equivalent to the Downtick Rule to worry about - you can absolutely drive up stock prices perfectly legally, provided that act isn’t part of some other illegal scheme like a pump and dump). But then how does the buyer make money? They buy a ton of stock of a company that still might go out of business. It's less likely to go out of business that way, but you don't get to find that out for another year, and it's not so much less likely that this strategy would have the same level of profit as short selling a company that then goes to zero right away because they couldn't raise the capital immediately required to continue operations. > Think about it this way: if short selling were the act that it is often made out to be we would see every stock driven to zero by these all-powerful short sellers. You can't just go short Apple and expect it to drive them out of business. It only works for a company which is already at risk, to push them over the precipice. And it's a high risk strategy. If you fail to drive them out of business you could lose a lot of money. But if you succeed, you make a lot of money at the expense of the people who lose it to you.

peterbonney 5y ago
> But then how does the buyer make money? They buy a ton of stock of a company that still might go out of business. But then how does the short-seller make money? They short a ton of stock of a company that still might not go out of business. See how it works both ways? As for everything else, I don’t know what to tell you - there is no basis in reality for your extremely narrow hypothetical construction, so there is nothing to argue with. As someone with some expertise in finance and investing I am telling you that you don’t understand what you are talking about, and I don’t mean that in an insulting way - this is complicated stuff. You can choose to ignore me as an a-hole on the internet, or you can choose to take the feedback and accept that there is more for you to learn on this subject before you offer opinions. It’s entirely your call.
pyuser583 5y ago
If a company only has a 50% of paying back a loan, there's more going on the a cash flow problem.

pyuser583 5y ago

My understanding is that short selling is basically a type of insurance. Is that correct?

GlennS 5y ago

Thanks for this explanation. I found it really useful.