By Sebastian Hawkes
Stock shorting gets a bad reputation because shorters want to see the price of stocks go down. Shorters lost billions in the famous GameStop squeeze, which saw the stock increase by 1900% at the start of 2021 (Investment U 2021). According to an avid investor at Walter Payton College Prep, “shorters were the enemy of the people, hoping GameStop would crash while everyone else was pushing for it to go up”. However, stock shorting plays a critical role in balancing our stock market.
Shorting a stock is more complicated than buying one. A shorter borrows a stock from a lender, and they sell that stock at a certain price. Then when the stock price decreases, they buy it back and return it, pocketing the extra money for a profit.
"This is a really important way to express the view that a company is overvalued via the stock market,” said Jennifer Han, Chief Counsel and Head of Regulatory Affairs at Managed Funds Association. “People see shorters as the skunk at the garden party, but it’s important for investor protection for there to be a mechanism for market participants to express negative views in stocks based on conclusions of their research.”
If traders only express positive views by purchasing stock, then companies become overvalued. This leads to bubbles, where stock prices are too high and eventually crash. An example of this would be the ‘08 housing bubble, in which the S&P 500 dropped 55% from October 2007 to March 2009, according to Investopedia. If it weren’t for shorters expressing negativity in related stocks, the bubble would have gotten even bigger before the collapse.
Not every company will succeed, and not every stock needs to go up. So while it may be upsetting to see others thrive when a stock you may own goes down, it’s important to remember that we need stock shorting to keep balance and fairness in the stock market.