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Short Selling

 

Short sellers who sell in anticipation of price decline are called information based traders. They believe that a security is over-priced and thus by shorting they contribute to market efficiencies. Portfolio managers sell short to hedge another holding of securities within the same industry. Before 1983, "no solely" short selling funds existed. It was usually only done by hedge-fund mangers and sophisticated individuals. After the 1990 market corrections occurred, additional short sellers to be part of this investment strategy.
             Short sellers encounter boundaries when using this form of investment. Restrictions such as institutional prohibitions, transaction costs and borrowable shares exist on short selling since stocks do not trade at only one efficient price, but within a band of prices. Therefore, portfolio managers know to look for mispriced stocks since there exists more overpriced stock than underpriced. There is also a high correlation between stock prices and high short interest. This indicates that stock prices reflect positive information more efficiently than negative information. As a result, short-interest ratios have proven to be bearish. A sudden negative-earnings surprise affects stock prices at a greater degree than what a positive-earnings surprise. The price of a stock will go down at a greater degree when earnings expectations are not met than what would occur to the stock price if the earnings exceed that anticipated amount. Another opportunity that exists for short sellers to practice their strategies is when bubbles form and collapse. Many studies have been conducted as an attempt to discover why prices vary from their intrinsic value. A suggestion that has been made to this theory is that fads linger in the security market because institutional investors are too averse to risk and aware of short-term relative performance to bet against the fad and sell.


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