Since the stock market crash of 1929 and the ensuing Great Depression, short selling has been the scapegoat for many market crashes. In a short sale, an investor sells shares in the market, which are borrowed and delivered at the time of liquidation. The intention is to obtain benefits by buying shares to repay those borrowed at a lower price. Following the Great Depression, the United States Securities and Exchange Commission (SEC) imposed limits on short-sell transactions to limit excessive downward pressure.
While short selling has been blamed for market declines and some have described it as unethical, as it represents a bet against positive growth, many economists and financial professionals now recognize that short selling is a key component of an efficient and well-functioning market, as it provides liquidity to buyers and promotes a greater degree of price discovery. Even so, exchanges and regulators have imposed certain restrictions to limit or prohibit short selling from time to time. Throughout history, regulators and legislators have banned short selling, either temporarily or permanently, to restore investor confidence or stabilize falling markets, with the belief that short selling caused or worsened the crisis. Over the years, many governments have taken steps to limit or regulate short selling, due to their relationship with a series of stock market liquidations and other financial crises. However, absolute prohibitions have generally been repealed, as short selling is an important part of daily trading in the market. An essential rule for short selling involves the availability of the shares that are going to be sold.
The stockbroker must be able to easily access it in order to deliver it at the time of liquidation; otherwise, it is a failed delivery or a short sale. While in a stock exchange transaction this is considered a default, there are ways to achieve the same position by selling options or futures contracts. The localization standard requires the broker to have a reasonable belief that the capital that is going to be short-sold can be borrowed and delivered to a short seller on a specific date before a short sale can be made. The closing standard represents the increase in the number of delivery requirements imposed on securities that have many protracted delivery failures in a clearing agency. Research has confirmed this theory by demonstrating that prohibitions or regulations such as the uptick rule did not promote stability.
In fact, short selling is still legal in much of the world today, and temporary prohibitions or restrictions on short selling due to market turbulence have been lifted once those crises have abated. Short selling in the spot market has a restriction: it has to be done strictly intraday. This means that you can start the short trade at any time of the day, but you will have to buy the shares (square) again at the end of the day before the market closes. You cannot hold the short position for several days. To understand why short selling in the spot market is strictly an intraday issue, we must understand how the stock market treats short positions. The United States Securities and Exchange Commission (SEC) has imposed restrictions on short-selling transactions in order to limit excessive downward pressure on markets since 1929. These restrictions include localization standards which require brokers to have reasonable belief that capital can be borrowed and delivered before making a short sale; closing standards which increase delivery requirements for securities with protracted delivery failures; and intraday restrictions which require traders to close their positions before markets close.
While some have described short selling as unethical due to its bet against positive growth, economists recognize its importance in providing liquidity and promoting price discovery.
