Time and time again I hear about how banning shorting, or restricting shorting is counter-productive and would require banning or restricting going long. I had a think about this over the weekend and have come to the conclusion it is not the same thing, but very different in two major aspects; psychology, and impact on the innocent.
Let’s start with the psychology aspect. Humans by their very nature a risk adverse creatures. It is actually a very good behaviour to have because it ensures survival of the race. There was a time when humanity was not the top of the food chain, but part of the food chain. To survive humans had to be afraid of dangers because it kept them alive for another day. Essentially humans avoid certain types of risk to be able to continue procreate and keep the human race alive.
Even though these days the necessity to survive due to physical dangers has dramatically reduced we replaced it with survival instincts related to monetary means. A father or mother of two children will take less risk with their job because they know they have to feed and support their children. An individual who has a mortgage will take less risk because they will want to pay off the mortgage and keep a good credit rating.
Yes, there are many exceptions to the rule and those that are willing risk it all in the hopes of a bigger payout. I am not denying that. What I am saying is that there are more people who are adverse to risk than take risk. Framing this in the context of the market it means that more people will be more likely to sell to protect wealth than buy to make wealth. The doubt in people’s mind will be more negative than positive regardless of the market conditions.
Thus somebody who goes short will prey on the psychological fear of the individual than the mounds of people who go long in the hopes of making more money.
Second point of innocent bystanders. With all things being equal what is the ability of a CEO, or managers in their ability to perform their work with a higher or lower stock price. If the stock price is higher due to whatever reason a manager can attract talent, can make buyout or merger offers and attempt to grow the business. If a stock price is lower a manager is hampered in their ability to merge with a company, or attract talent.
The problem is that a stock price tends to be forward looking on public information. Remember insider information is not allowed and illegal. Thus if a set of analysts are saying a stock is bad, without real information they are causing a stock to collapse. An increasing stock price does not result in a self-fulfilling prophecy because a company might not be doing better or might not take advantage of the increasing stock price. This in turn can cause a company to collapse because the forward information becomes the current information. A sort of self-fulfilling prophecy.
Again I am not against shorting because the market should be able to say to the company, "hey we don’t like what we are doing and we are going to bet against you." But what a market should not be able to do is say, "hey you are dog meat and we think what you are doing sucks and we are going to drop the price to zero or as close to zero as we can."
That’s why whenever you hear shorting is like going long is not telling the complete story.