Why they hate short sellers

Every marketand every game has its own whipping post.

In baseball, it's the umpire.At the gas pump, it's the big oil companies. And in the stock market, it's the short seller.

On Thursday, Sept. 18, British regulators banned short selling on theshares of 29 U.K. financial firms until January; they subsequently added four more companies' stocks to the list.

The U.S. Securities and Exchange Commission followed suit the next day, suspending short sales for 10 trading days in the equities of 799 financial service institutions.

Other countries, such as Canada, aremulling over a similar cease-and-desistorder.

With all theprohibitionsflying around global stock markets,one gets the sense that the short seller is about as popular in the investment world as a plate of broccoli at a seven-year-old's birthday party.

"I hate short sellers! They should be banned from the market," said one e-mailer writing in a financial chat room.

Cashing in on fallingmarkets

In fact, short selling is a pretty common wayspeculators make money in the modern stock market.

Essentially, these people make their coin by selling shares they do not own. It might sound shady,but the transaction is all legal.

First of all, the person finds a buyer for the stock issue in question. Then, this sellerborrows the shares from his or herbroker or another investment house to hand overto thepurchaser.

At some future point, say in a month's time, the investorneeds to return what they borrowed to the investment house in market jargon, it's known as "covering."

So the short seller goes on the open market, buys the stock andgives it back to the original lender.

The method by which investors make money on this transaction is the same reason they are so reviled by many stock traders; they make a profit only if the share pricedrops.

The math works like this: Suppose the "short," as this type of investor is known, sells a particular stock for $100.Then, a month later, the same shares are nowworth $75.

The short sellerbuys backstock on the open market for the lower amount. But the investor had alreadyreceived $100 for the same stock one month earlier.

In this example, theinvestor makes $25 incurring only slightly more risks than if she had bought the shares hoping they would go up.

Gilded pariahs

Like real estate brokers, manyinvestors often try to talk up the stock market as a buying opportunityno matterthe circumstance and thus hate short sellers, who applaud falling markets.

Stock purchasers basically believethe shorting crowd is inherently evil, circlinglikevultures and picking away at good companies until their stock values begin to fall, causing panic in the marketplace and destroying fine firms.

Billionaire Philip Falcone, whose firm reportedly earned the equivalent of $536 million when the share price of distressed U.K. mortgage bank HBOS fell this month,is known as the "Midas of Misery" because of the 45-year-old'sability to make money in bad markets.

Stock speculator Jesse Livermore reportedly made $100 million US in the stock market crash of 1929.

Government worries

U.S.and other regulators probably did not institutetrading bans on shorting stocks because of such long-standing prejudices.

Instead, these securities experts appearworried that short selling was injectingtoo much downward pressure onstock marketsalready brimmingwith bad feeling and teetering on the brink of a major collapse.

The fear wasthat nervous investors would interpret amild drop in a company's share value as a reason to dump the stock in areckless manner.

The bans onshort selling appeared to removethat negativepressure on stock prices and push back some optimism into stock valuations.

Of course,the same daygovernment put a halt to shorting, Washington unveiled a new plan to remove bad debt from the balance sheets of ailing U.S. financial firms.

It's hard to know which weighed more on the markets, but regardless, on Friday the Dow Jones industrialaveragewas upmore than 300 points.