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The entity victimized here isn't the buyer who is going short it is the company that is "falsely" shorted. An extremely contrived example: Say a company has a

The entity victimized here isn't the buyer who is going short it is the company that is "falsely" shorted. An extremely contrived example: Say a company has a 1000 shares of stock out in the market. The broker buys 250 of the shares to sell to the person who wants to short the stock. So if you were looking at this stock from the outside you'd think: "There are 750 shares where people think the price of the stock is going to go up (or why else would they have bought it) and there are 250 shares where people are betting that the price is going to go down (which is how you make money by going short)". Note the 750 shares + 250 shorts = 1000 shares So if someone wanted to short this company on 500 shares, the broker can't find the extra 250 on the open market so they sell the short positions even though they don't have a stock to associate against the last 250 (hence they are "naked"). So you have: 750 shares + 250 actual shorts + 250 naked shorts = 1250 positions in the market on a company that only has issued a 1000 shares. So now you're an investor and you're trying to guess what the future share price of a company will be and you have: Company A with legit shots which you can think of as 750 bets the stock will go up vs 250 bets the stock will go down. and Company B with naked shorts which you can think of as 750 bets the stock will go up vs 500 bets the stock will go down. You'd look at the two of these and go: "Gee, there sure are more people in the world that think Company B's price is going to go down. I'm going to sell my Company B shares before they really tumble and buy up some of that good Company A." So the naked shorts make Company B look less attractive which drives the price down further (making more money for the short positions).

nsrivast 17y ago
In this situation, there are more bets/people/indications/information that Company B's price will go down. Yet Company B does not necessarily look less attractive - a high amount of short sales might mean a rise in the price when people cover (buy back) their shorts.
- michaelbuckbee 17y ago
  The less/more attractive is a matter of interpretation. The core issue is that there are two different sets of rules applying to Company A (no naked short selling) and Company B (naked short selling), but to an outside observer it would appear that there is only one set (no naked short selling as per regulations). This messes up even things like what you are describing: as half the shorts on Company B are naked, there aren't any shares to be bought back, so there would likely be less of a rise than what you would expect.
yangyang 17y ago
> The broker buys 250 of the shares to sell to the person who wants to short the stock. No. The entity that wants to short will locate (or get their PB to locate) shares to borrow that they will then sell, in order to short. They will pay interest on that borrow, and it can get quite expensive if that stock hard to borrow. They have to return the shares at some point - either when they decide to cover their short, or the lender recalls them. Either way, the lender is still "betting" on the price going up, as they will get the shares back at some point in the future.
- pieceofpeace 17y ago
  If the stock is borrowed it is a covered short. The problem is with naked shorts where you sell without even locating. Or when you put 'three dots' (as the Goldman Sachs compliance officer remarked in a conference) in the text field to report where you have located or borrowed the shares. In short (pun intended) selling without borrowing proves destructive for the price of shorted shares.
  - yangyang 17y ago
    Indeed. I did read the article and I'm aware of that anyway. I was responding to the comment.
  - pbhjpbhj 17y ago
    It's incredible really that this was allowed to happen - if you've enough money then you're allowed to sell shares in a company you don't have any interest in (ie don't own shares of). Idiocy. Anyone want to buy Manhattan, ... the title deeds, oh I'll show you them next week.
Xichekolas 17y ago
> So the naked shorts make Company B look less attractive which drives the price down further It's not even a matter of attractiveness (although false rumors would definitely fall in that category). If you have more people trying to buy a stock than those willing to sell (at the current price), the price will rise until more people are willing to sell or fewer people are willing to buy. Likewise, if more people are looking to sell (at the current price) than to buy, the price will go down until people are either no longer willing to sell, or more people want to buy. Naked shorting creates excess supply. You suddenly have A LOT more 'shares' being sold, without a corresponding increase in buyers. As such, the share price declines. Couple this with nasty rumors, and the declining share price doesn't entice any new buyers (which is normally the case when something gets cheap). As the price caves further, and the rumors persist, existing owners start to worry, and decide to get out before it gets worse. Now the downward spiral is in full force. Everyone wants off the sinking ship.
- rwmj 17y ago
  > As the price caves further, and the rumors persist, existing owners start to worry, and decide to get out before it gets worse. Now the downward spiral is in full force. Everyone wants off the sinking ship. Can you explain how the company goes out of business as a result of this? Suppose the company is basically sound. Through stock manipulation its share price goes down to 1 cent. But the company continues doing whatever it does (and can purchase its own shares back at a bargain price to boot).
  - Xichekolas 17y ago
    Well, if the company were basically sound, it wouldn't go out of business... although it'd be mighty ripe for a hostile takeover. But Bear, Lehman, and numerous small companies that are usually the victim of this tactic, were leveraged to the gills, and were full of nasty liabilities. The temporary crisis of confidence caused by a falling stock price led creditors to start fleeing as well, preventing Bear from rolling over it's daily debt. As they point out in the article, Bear was highly dependent on overnight lending at that point. Also, making money via naked shorting doesn't require the company to die. It merely requires the share price to fall.

nsrivast 17y ago

In this situation, there are more bets/people/indications/information that Company B's price will go down. Yet Company B does not necessarily look less attractive - a high amount of short sales might mean a rise in the price when people cover (buy back) their shorts.

michaelbuckbee 17y ago
The less/more attractive is a matter of interpretation. The core issue is that there are two different sets of rules applying to Company A (no naked short selling) and Company B (naked short selling), but to an outside observer it would appear that there is only one set (no naked short selling as per regulations). This messes up even things like what you are describing: as half the shorts on Company B are naked, there aren't any shares to be bought back, so there would likely be less of a rise than what you would expect.

yangyang 17y ago

> The broker buys 250 of the shares to sell to the person who wants to short the stock. No. The entity that wants to short will locate (or get their PB to locate) shares to borrow that they will then sell, in order to short. They will pay interest on that borrow, and it can get quite expensive if that stock hard to borrow. They have to return the shares at some point - either when they decide to cover their short, or the lender recalls them. Either way, the lender is still "betting" on the price going up, as they will get the shares back at some point in the future.

pieceofpeace 17y ago
If the stock is borrowed it is a covered short. The problem is with naked shorts where you sell without even locating. Or when you put 'three dots' (as the Goldman Sachs compliance officer remarked in a conference) in the text field to report where you have located or borrowed the shares. In short (pun intended) selling without borrowing proves destructive for the price of shorted shares.
- yangyang 17y ago
  Indeed. I did read the article and I'm aware of that anyway. I was responding to the comment.
- pbhjpbhj 17y ago
  It's incredible really that this was allowed to happen - if you've enough money then you're allowed to sell shares in a company you don't have any interest in (ie don't own shares of). Idiocy. Anyone want to buy Manhattan, ... the title deeds, oh I'll show you them next week.

Xichekolas 17y ago

> So the naked shorts make Company B look less attractive which drives the price down further It's not even a matter of attractiveness (although false rumors would definitely fall in that category). If you have more people trying to buy a stock than those willing to sell (at the current price), the price will rise until more people are willing to sell or fewer people are willing to buy. Likewise, if more people are looking to sell (at the current price) than to buy, the price will go down until people are either no longer willing to sell, or more people want to buy. Naked shorting creates excess supply. You suddenly have A LOT more 'shares' being sold, without a corresponding increase in buyers. As such, the share price declines. Couple this with nasty rumors, and the declining share price doesn't entice any new buyers (which is normally the case when something gets cheap). As the price caves further, and the rumors persist, existing owners start to worry, and decide to get out before it gets worse. Now the downward spiral is in full force. Everyone wants off the sinking ship.

rwmj 17y ago
> As the price caves further, and the rumors persist, existing owners start to worry, and decide to get out before it gets worse. Now the downward spiral is in full force. Everyone wants off the sinking ship. Can you explain how the company goes out of business as a result of this? Suppose the company is basically sound. Through stock manipulation its share price goes down to 1 cent. But the company continues doing whatever it does (and can purchase its own shares back at a bargain price to boot).
- Xichekolas 17y ago
  Well, if the company were basically sound, it wouldn't go out of business... although it'd be mighty ripe for a hostile takeover. But Bear, Lehman, and numerous small companies that are usually the victim of this tactic, were leveraged to the gills, and were full of nasty liabilities. The temporary crisis of confidence caused by a falling stock price led creditors to start fleeing as well, preventing Bear from rolling over it's daily debt. As they point out in the article, Bear was highly dependent on overnight lending at that point. Also, making money via naked shorting doesn't require the company to die. It merely requires the share price to fall.