Author: Michael Arold
Covestor model: Technical Swing
Disclosure: Short LDK, JOE, ANN (as of 6/6)
Selling a stock short is sometimes branded “immoral” because short sellers hope that the price of a stock will decline and generally benefit when a company whose stock they’re short struggles or even goes bankrupt. The short seller profits, the argument goes, when employees lose their jobs and the firm shuts down. A traditional long-only investor, on the other hand, puts his money into a company’s equity base, which the company uses to invest in new businesses and thus create jobs.
Selling stocks short is an essential part of my model portfolio’s strategy. I disagree with the notion that shorting is immoral.
Concerning the jobs argument, I believe that long-only investors actually benefit more frequently from job cuts than short sellers do. One often observes that news of a staff reduction actually increases the stock’s price, due to expected gross margin improvements. For example, the last two years have been characterized by a “jobless recovery”: earnings and stock prices have been soaring, but broadly speaking companies have been laying off workers – or at least not hiring.
One argument for short selling is increased liquidity. Short sellers add liquidity to the market because they have to cover their positions eventually by buying the stock, often when everybody else wants to sell. Without the short seller, prices would fall even further.
Another argument is company pressure. Initially, a stock can fall faster when it is targeted by many short sellers. A declining stock price puts pressure on management to change the direction of the company. Thus, short selling increases the positive dynamic of the entire economy. The ability to quickly adopt to new market conditions is one of the biggest strengths of the U.S. system. Short selling has its role in that process, and I therefore don’t consider it immoral.
