We have previously written about the folly of short-term trading and speculating on rumor and innuendo with respect to how "investors" deploy their hard-earned capital. This time, however, we are coming to the defense of traders and speculators.
Much has been made of the move in oil prices this last year. Many have blamed "speculators" as being at the heart of the problem and only if they can be stopped we would see a return to "normalcy" in the price of oil and other commodities. This nonsense emanates mostly from Washington D.C., so perhaps we should recognize the source of such commentary and act accordingly. Yet, while we are not suggesting there is investment merit in making what amounts to a bet on what the price of oil will be tomorrow, we want to emphasize the importance of traders and speculators in the market every day.
We stick to our beliefs that one should not base his investment decisions on what traders are doing at any given time, but without those traders there would be no market. Trading activity (both short and long) provides the liquidity investors need in order to raise cash from their long-term investments when the need arises or when the determination has been made that the investment in question has reached full value.
In addition, the practice of shorting stock (borrowing stock one does not own and then selling it in order to buy it back later at, hopefully, a lower price) serves another purpose of keeping the management of public companies honest about how they run their operation. The self-correcting force of those who short stocks acts as a barometer of management's effectiveness. If management stumbles for any reason, the short sellers are there to trounce the stock and send it down in a hurry, creating a situation that the management of most firms surely hope to avoid. Certainly the pain can be drastic, in the short run, and often good companies and management teams can be unfairly judged by the sellers. However, the benefits to the market and investors in the long run outweigh the negatives a lower stock price can bring about.
However, while recognizing the benefits of trading and in particular of shorting stock, there is a disturbing trend that has been identified lately which worries us with respect to short-selling stock. The act of shorting itself, which requires the seller to borrow stock and then sell it, seems to have been distorted by those who are fraudulently shorting stock before they borrow it (a legal practice called "naked shorting") and then failing to deliver the stock they have sold. This is a very serious problem if allowed to continue unchecked. A 2007 Bloomberg News piece, here, highlights the pervasiveness of this activity and asks some crucial questions as to why this has not been dealt with more harshly up to this point.
It may well be that companies are being targeted by these unscrupulous traders and -- more significantly -- if there are broker-dealers that are complicit in this practice, they need to be handled immediately and without sympathy, as it is activities like these that undermine the fabric of the free enterprise system.
More on this as the story develops but, meanwhile, we need to give honest traders who play by the rules a break. Stay tuned . . .
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For later posts relating to this same topic, see also:
- "Being short is not automatically evil" 04/27/2010.
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