Page 254 - THE MARKET WHISPERER

250 PART 8 - Shorts: Profit From Price Drops

• The purpose of shorts is to profit from dropping stock prices.
• Selling a stock short means borrowing shares from the broker who in

turn borrows from one of his or her clients.
• If the broker cannot lend them, such as when they are out of stock, we

cannot execute a short, in which case the opportunity must be waived.
• “Short squeeze” means that a stock is rising sharply usually due to

some good news about the company, which sets into action a wave of
shorters rushing to close their position, which in turn causes the price
to jump even higher disproportionately to the company’s true value.
Is the explanation now complete? No. It gets even more complicated.

Naked Shorts

We will now take a look at the dark side of short selling and learn about
the phenomenon known as “naked shorts,” so called because they have
no real cover. The phenomenon occurs when a large organization, usually
a hedge fund, interested in shorting a very large quantity, sells shares it
cannot borrow!

How can it do this? After all, we have just learned that shorts cannot
be executed on shares that cannot be borrowed. But as we know too well,
nothing stands in the way of those who really desire something, and market
makers can make that something happen. They do this by selling shares
they do not have, and transferring these “naked shorts” from one account
to another for periods so short that the regulatory body cannot follow the
trail. They can also do this by executing shorts in stocks of US dual-traded
companies which are simultaneously traded on stock exchanges outside
America. These foreign stock exchanges are not concerned with enforcing
the regulations.

Why would organizations make a naked short trade? It often creates
big business, especially during periods when the economy is weak and
the dollar has dropped heavily compared to its competitors. In such times,
company values drop, they weaken, and eventually are forced to issue
more shares in order to recruit funds. This works in the shorters’ favor.
Even shareholders may eventually be forced to sell more shares which
until that point had not been in circulation in the market.

Naked shorts are not listed anywhere, so if you look at Yahoo Finance
and see that a company with 30 million traded stocks has 3 million shorted,
you can be sure that 3 million actually means nothing, and has the same