Benefits and Pitfalls of Short-selling Shares

1789 Words Feb 26th, 2018 7 Pages
The sellers gain profit when they buy back the shares at a lower price (Investopedia, n.d.). The benefits of short-selling include facilitating market efficience, driving down overprice shares, increasing liquidity of stock markets and exposing financial fraud. The CFA Institute believes that short-selling enables “participants to quickly and accurately adjust securities prices to reflect investor opinions about valuations” (Smith, 2012), hence improving marketing efficiency. It also shortens the time taken to discover corporate misconduct and predict firms who will be involved in financial misconduct (Foster, 2009).

However, short-selling has its limitation as well. Firstly, it has detrimental effect which weakens investors’ confidence in financial markets. It gives rise to short-term market volatility and cause severe damage to investors’ confidence when share prices decline. Secondly, there is an unlimited risk involved as there is no limit to the amount of money the short-seller can lose, the price of the share can increase forever (IG, n.d.). Lastly, the companies involved would need to preserve their reputation and pay for the negative publicity with higher funding costs (Smith, 2012).

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