Special Report: "Shorting --> Supply meets Demand".
Much to do has been made over Shorting and Shorters recently. Claims that Shorting is evil, that Shorters are all matter of things, have been literally been shouted out on message boards. Web Sites have been put up that imply any negative information towards the financials or fundamentals of Public companies, should be ignored. They assert anyone not Long a Stock should not be trusted and is not telling the truth. "Check your negativity at the door", is the message. The implied stance for proper postings on the message boards is that all discussion should be comprised of the nothing critical or challenging to the stock. It reminds one of "The Three Monkeys" statue. You know?the one with a chimp covering their eyes, the next chimp its ears, and the last chimp its mouth...See no, Hear no, and most of all, Say No bad things about "our" stock. (Note: there is a fourth chimp, which is throwing darts at list of stocks to make professional picks, but that story is for another time '-)
These novice beliefs about Shorters have become so common, that the misrepresentations have seeped into the more Tabloid of Stock Journals. We see Journalist pursuing personalities before fundamentals, which are driving the trading. Suddenly we are in the mode of feelings, and not facts. Well as you know, if you read it on the Internet "it's gotta be true!" Right?
Well maybe not, let's look at the mechanics of Shorting and find out just what is involved in the wicked, nasty, unclean process. Trades in Shorting are exactly like a Long Trading, when profitable. Both involve "buying low", and "selling high". The only difference is that the trading order is reversed. With Shorting you "Sell High" first, then "Buy Low" second. Each and every trade has a buyer and a seller. Each trade is just the same as any other buy or sell; an agreed Price is transacted on between two willing investors.
So why are these Long traders, claiming that shorting is an "Evil Attack" on THEIR stock, such as Widgets.com (Nasdaq:WIDG). Well its simple, its Supply and Demand. Or perhaps Supply vs. Demand.
When a stock has gotten the now proverbial "CNBC Pump #1", the Demand to own shares increases. As in "instant-on Spike-O-Matic". Often the CNBC factor will be as simple as the announcers noticing the stock is active in premarket trading. That mention can put the stock in play, and give it much greater Demand. Many early birds want that worm. Given a finite Supply, in order to become a holder of the stock the prospective owners will need to bid up the Price to assure entry. So, clearly the increased Demand causes the Stock Price to go up.
So everyone is still happy the stock is going up, Supply of shares is hard to come by. Costello trots up to the Nasdaq wall, fresh from reading his book "A Dummies Guide to Hand Gesturing." (That is the re-titled version of the best selling "WhatsaMattaYou! Hand Gesturing the Italian Way"). Costello, proceeds to turn his back to the camera, points to WIDG with his script to the Nasdaq wall, reads a price, which changes as he speaks, then refers to the news story driving WIDG. He says simply "its up on News of the new contract with DotComRetailer", nothing else. We will call this Pump #2. We still know nothing other than Costello is exited, not a rare event, but hey, sure enough folks are soaking up those Widget shares.
It's in the financial interest of long traders who have built their positions, to have Supply restricted. The intersection of the Supply and the Demand curves is the Price point. Increased Demand without increased Supply will cause the Price to go up. So, we now have a stock that has been in a trading range of 7-9 dollars suddenly up to 15-16 dollars. In this scenario, Demand is very inelastic to Price. I think it would be an inverted slope where higher Prices actually cause more Sales. That inversion is unique and transitory characteristic of a momentum stock play of the day, in its spike mode. So, we have many new interested prospective owners of Widgets.com. Demand is high, Supply is limited, and prices are bloating.
What often happens now, is that Shorters will step up, and offer additional shares for sale. The Long traders are not happy about it either. But as Greenspan will tell you, it's the efficient Market, and Supply is made available to meet the Demand. It's both efficient and rational, and has nothing to do with much else. By offering additional shares, it allows the Demand to be met, without the need to push up the Price. This is of tremendous benefit to prospective new purchasers of the stock. By having the increased Supply they can enter the stock at a more advantageous cost. Shorting causes a temporary overall increase in the total Supply of shares possible to be owned. Stock is held at the brokerage, and is also sold to a new buyer, with a promise of the Shorter to repay the borrowed shares to the brokerage. By increasing the Supply of shares, the stock is not "attacked" however the increased Supply does lessen the upward Price pressure due to constrained Supply. So there it is, that is it, that is the nasty Shorter and effect. Longs are referring with all their venom to that modest effect. Shorting increases Supply, and requires a reciprocal Demand (purchase) in the future.
What often happens is that at the top of the chart both the longs and the shorts are selling as many shares as possible. Long-term owners want to be able to sell their shares to new investors at this time, handing over the bag of goods. Because of the uptick rules, and other factors, it is far easier for a Long holder of shares to sell as the stock goes down. For the most part, Longs can sell to new buyers before Shorts can when the stock weakens. At the top, Supply will meet Demand, as the new Purchasers become owners and new Demand is not gained, the Price will move towards the next price point where demand exists. As seen on Level Two.
In spite of all the dire messages of doom and gloom about the nasty Shorter motivations, in objective reality, the long and the short are no different really, that just have different starting points. With the knowledge that Demand (i.e. volume) has a clear relationship to Price per a given Supply:
* The Long attempts to buy early and hopes for increasing Demand.
* The Short attempts to sell late and hopes for decreasing Demand.
* Both want to Buy Low, and Sell High
Which takes us back to Costello. Well the news that the drove Widget up 100% turns out to be a contract for DotComRetailer's new "Local stores". Being and Internet Retailer primarily it means they only will have (5) local stores and no plans for new ones. After some quick estimates of the cost of the Widget, and the number of stores, it appears that the Contract value is well under $150,000. Oddly enough, the Market capitalization of Widget just went up 20 million dollars throughout the first half of the day. Costello tell us that his talked to "some people" and the don?t view this as significant news, then says, but investors sure seem to, stock is up 100% today. The stock will not be mentioned on air again for 2-4 months.
As the facts come to light, Demand is severely hurt. Some aggressive Longs may want to blame Shorters for giving out the information. But that is a case of shooting the messenger and not fair to the Shorter. There is a daily exchange on every message board Longs vs. Short both sides can and will cross the line, but on balance they are a wash. Clearly, what will determine this stocks fate was the greater Media's distilled reporting. Its the sound-byte reporting of the News that caused the misperception of the facts, which created the dramatic Demand in the first place. In any case, the correct news is will come out.
The Demand for Widgets stock, after its Price doubled, was reduced. Nobody wants to buy the stock at the higher Prices. As the facts come out about the quality of the Press Release demand is further decreased. But there is a real benefit to having Shorters in the stock at this time for the Long holders. There is an artificial level of buying interest because Shorts that will cover as the Price comes down. Various Shorts sold a various volumes and dollars, with various objectives and goals met. As the stock goes back to it proper levels of valuation based on merit and not MoMo hype, it does his gradually. Many Longs will hype the reasons for this. But it is simply the artificial Demand to buy shares from the shorts. That Demand gives exit space for Longs who bought the top to get out. This dynamic, yields a chart with a Spike up, and slope down, looking like the grade of an intermediate Ski hill. Only the uninformed investors believe that the stock was attacked and hurt by the shorts. The shorts may change the time frame, but the outcome is in the company's hands.
Summary: The act of Shorting is simply an "Efficient Market" mechanism to match Supply with excess Demand. Price remains the result of interaction of that Supply and Demand. Shorting is the same as Longing, except the sequence of trades is reversed. "Buy Low" and "Sell High" remain the key trading actions for profiting in either style. If Shorting occurs with unlimited Demand, it is a loosing venture, and the risk can be very real. Shorting takes far more energy than the average Long trade, and Due Diligence on the part of Shorters is often frustrating for Investors who do not understand why they bought the stock. Each side has their positives and detractions, but the transactions themselves are neutral. Some Longs are aggressively optimistic and some Shorts are aggressively pessimistic. Optimism in general society, is considered virtuous, so the Longs may feel better, but are really no better. Today's sound-byte style of profit focused News departments, cannot differentiate their brand by reporting the news only. Because of the Internet, the straight fact news, is a near real-time instant commodity with multiple sources. To get the audience size to match sales goals, the news must have "story". Few stories sell better that "Big Bad Shorter" coming in to gobble up some Piggies.
That is a case of crying...
Wolff
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