Finally, after almost three decades, the Philippine Stock Exchange (PSE) will be able to offer short selling starting Oct.23.
Short selling is an investment process which involves borrowing shares of stocks (or security) whose price is anticipated by the borrower to go down and later selling them at that lower price.
The difference between the price of the security at the time it was borrowed and the price it was sold represents the investor’s profit.
The companies that would be eligible for short selling are those in the PSE’s Midcap index (which consists of mid-sized companies that meet specific liquidity and market capitalization criteria) and Dividend Yield index (which lists companies that consistently give high-yielding dividends).
The PSE believes short selling would help boost the capital market and would encourage small retail investors to participate in its trading activities.
Historically, short selling has produced favorable results in the bourses of well-developed economies.
Although there had been reports of misuse of this investment practice in those countries, short selling has, by and large, been properly supervised by their regulators.
Some investors who had access to insider information and exploited loopholes in trading regulations had been convicted of illegal short selling and ordered to serve long prison terms and disgorge their profits.
Short selling is not for the lay person or occasional stock trader. It requires a keen understanding of, among others, the financial statements and operational plans of the company whose stocks an investor want to short, and their possible effect on its price within a particular period.
What’s more, the short seller should have money that he or she can afford to lose in case things don’t go as expected.
Note that the profitability of short selling depends on the price of the shorted stocks going down at a level low enough as to make selling them profitable.
Breaking even is not acceptable because broker’s fees have to be paid and, worse, if the money used to buy the borrowed stocks was sourced from a loan with a high interest.
If the price does not go down or otherwise goes up, the short seller has to pay for the borrowed stocks at its acquisition cost when the stockbroker demands the payment for those stocks.
In other words, it is in the short seller’s best interests that the stock price tanks otherwise he or she could find himself or herself in serious financial trouble. And if he or she happens to act on behalf of or had otherwise advised third parties to do something similar, the reputational damage could be irreparable.
In stock market trading, that flaw would be a kiss of death.
Recall that there had been instances in the past when damaging rumors or loose talks in the business community or the media about some companies had caused their prices to go down.
Although the affected companies were later able to clear the air, the harm had been done and it took some time for their stock prices to return to their earlier level.
In today’s highly digitalized world, timely-placed and cleverly composed adverse social media posts about a company or its executives could make its investors jittery and unload their stocks and, in the process, pull down its price.
Note that social media is like a forest fire, it’s very easy to ignite but very hard to extinguish.
A short seller whose expectations of a price dip failed to materialize and is facing the prospects of a huge financial loss could use social media to create uncertainty or distrust over those stocks to depress their price. The anonymity that the internet provides would make it difficult, if not impossible, to unravel the identity of that rogue investor.
Not only that. Any or a combination of the “fraud, manipulation and insider trading” practices listed in the Securities Regulation Code could be used to accomplish the same result.
Since short selling is, in a manner of speaking, virgin territory for the PSE, it has to make sure it works the way it should be practiced to meet its objectives. INQ
For comments, please send your email to “rpalabrica@inquirer.com.ph.”