Sunday, March 13, 2011

THE HISTORY OF SHORT SELLING

Short selling has been around since the 1600’s and it has always had good and bad opinions even from the beginning. In various examples throughout history, it has been labeled as a primary reason in large market declines.

WHO ARE THE BEST KNOWN SHORT SELLERS IN STOCK MARKET HISTORY?

There are theories that said that the practice of short selling was invented by Dutch trader Isaac Le Maire, a big shareholder of the Vereenigde Oostindische Compagnie in 1609. In 1602 he invested about 85,000 guilders in the Vereenigde Oostindische Compagni (VOC) and by 1609, the VOC still was not paying dividend, and Le Maire's ships on the Baltic routes were under constant threats of attack by English ships due to trading conflicts between the British and the VOC. Because he thought that eventually British ships will destroy some of the ships, there would be losses for Vereenigde Oostindische Compagnie, and as a result stock price will go down. So what he does? Le Maire decide to start another company with a few other people and front run the Vereenigde Oostindische Compagnie! He sold his shares and sold even more than he had. That moment, when he sold something (shares) he didn't owned, is a moment when short selling was invented. All this led to the first real stock exchange regulations, a ban on short selling.

In the 18th century, England banned short selling. The London banking house of Neal, James, Fordyce and Down collapsed in June 1772, leading the fall of other banks and finally leading to banking crisis which included the collapse of almost every private bank in Scotland. The bank had been speculating by shorting East India Company stock on a massive scale, and using customer deposits to cover losses.

The term "short" was in use from nineteenth century. It is commonly understood that "short" is used because the short seller was short ie. need shares to cover his position with his brokerage house. Jacob Little, known as "The Great Bear of Wall Street", was famous for shorting stocks in the United States in the early to mid 1800’s. (The picture above is the original certificate signed by himself). Another short seller, the great Jessie Livermore was the one who was blamed for the crash of 1929, because of his well known reputation.

SHORT SELLING REGULATIONS IN HISTORY OF THE US:

In Wall Street Crash of 1929, short sellers were blamed for it. After the crash,  SEC banned short sellers from selling shares during a downtick, and "uptick rule" was created. This means that a short sale order can only be filled after someone bought that same stock and their order caused an uptick when purchased at the Ask price. Some people believe that the uptick rule prevent stocks from dropping so fast and others believe the stocks would have gone down anyhow. This was in force until July 3, 2007 when it was removed. Legislation in 1940 banned mutual funds from short selling, until 1997, when this law was lifted. In 1949, Alfred W. Jones founded a fund that bought stocks while selling other stocks short, ie hedge market risk by using a combination of owning shares, using various stock option strategies and shorting the stock at the same time. This is how the hedge fund was born.

In September 2008 short selling, and naked short selling was seen as a contributing factor to undesirable market volatility, and it was prohibited by the SEC for around 800 financial companies for three weeks time.

WHO MADE THE HIGHEST AMOUNT OF MONEY IS A SINGLE SHORT SALE TRANSACTION?

In Black Wednesday of 1992, George Soros became became notorious for "breaking the Bank of England", when he sold short more than $10 billion worth of British pounds.

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