Finished reading Jim Rogers Street
Smarts last month, and he explained why short sellers are good to the market.
Difference between
Hedge and Mutual Fund

The difference between hedge and mutual fund is ability to
hedge which means can sell short. Mutual fund only can buy.

What is Short Selling

You buy a stock at $10 a share, and anticipating or wanting
it to rise. It then rise to $20 a share when you sell. Now you make a profit of
$10 per share.
Selling short is the reverse of the process.

Now if there is a stock trading at $20 a share, and you think
that it will fall to $10 – You are going to short it. What you do now is to
sell the stock at $20 and then buy it back at $10.
Hmm…if I do not have shares how do I sell?
For shorting, what you do is to borrow the shares from a
bank. E.g. I borrow 1,000 shares from a bank and sell the stock at $20. Now my
stock account has $20,000.
Then as what I predicted, the value of the shares drop to
$10. I then begin to buy back 1,000 shares at $10 which cost $10,000.
Now I return the 1,000 shares to the bank with interest. The
longer you borrow, the heftier the interest pay back. Discounting the interest,
I then make the difference of $10,000 (20k – 10k).
Why Short Sellers are

Excerpt from Jim Rogers Street Smarts:
Short sellers create liquidity and stability to the market
otherwise stock price will skyrocket and also otherwise during collapse, it will
collapse faster.

Market need buyers and sellers. Without sellers,
price will sky rocket. Without buyers, price collapse.
E.g. during Dot com mania, everyone buy Cisco. Price went up
from $20 to $80. Without Short sellers, price may go to $110, now it is $90. Without
sellers, there will be no liquidity, things will go nuts!

Let us say short sellers are wrong. They cover
their shorts, and summarily forced out of market. Stock will go up! But if
short sellers are right, (by the way, short sellers have a better record than
most Wall Street), stock price will head towards a collapse. Everyone will be in
panic and wanted to sell. But now there are no buyers! Well there is actually
the short sellers. This is because they have to replace the stocks they
borrowed. They have to cover their shorts! So in a collapse, stock does not
drop as much as it might have. Let’s say it will drop to 80 instead of 30.

So short sellers are good. They save you from
buying the failed stock at $110 – if you bought at the top, you bought at 90
instead. When you dump, the short sellers replace stock which you will be able
to get out at 80 instead of 30.

During an interview I gave on CNBC in 2008. Jim
Rogers shorted Fannie Mae. Fannie Mae was a sham and on verge of collapse. In
2008, it drop to 60 to bankrupt. It was down to 20 by then, and reporter
interview me – Sharin Epperson – opinion that collapse was Jim fault.

“Listen, I told Ms Epperson, as politely as
I could, “if you really think that Fannie Mae is going into the tank because
of short sellers, you really should get another job!”

Short sellers are
not the cause (of collapse), they are simply the messengers and as such they
exposed many of the great frauds. The criminal enterprise that was Enron is one
of the most famous scandals they are responsible for having identified!

Rolf’s Summary
I added this paragraph after blog mentor SMOL’s incitement that I
am not a parrot in the comment. LOL
In my opinion, for every buy, there must be a sell, and vice
versa. In a food chain, there exists predator/prey systems, and relationships
between herbivores and their food source such that a stable equilibrium is achieved.
This is called the “balance of nature” or homeostasis. Other examples are regulation
of temperature and balance of acidity and alkalinity in our body internal
environment in response to external conditions.
In the stock market it is no difference. We need a self-regulating
process in which buyers and sellers in a dynamic equilibrium continuously
change reach a balance.
So if there are no short sellers, how to achieve BALANCE during euphoria?

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10 thoughts on “Why Short Sellers Are Good

  1. Rolf,

    You have just summarised what Jim Rogers think about short-sellers.

    Drum roll…..

    What do you think? (Somehow I don't see you as a parrot)

    1. Hi SMOL,

      Your blog make people think. Your comments make people work.

      Thanks for the reminder. I always try to have a summary/view at the end of most of my article. This one I miss out….

      I have added a new paragraph in the above article and updated it.


    1. Hi Richard,

      I had never short sell before. I do not think I am ready and will definitely loose sleep now if I do.

      Anyway, I am already loosing sleep due to my newborn. Haha LOL.

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