Saturday, 19 July 2008

Naked Gun

Not in my trader's conscious mind (or even the subconscious) would I have ever imagined that the US market was also prone to some of the dirtiest tricks in the book but to a greater degree.

I'm talking about what they call naked short selling. No, it's not short selling while wearing your birthday suit. That's kind of kinky but that's not what it is. For those who are not familiar, short selling is a legal way for traders to make money in a market that's going down. You will first borrow shares (normally from your broker) and then sell this to the market when you perceive that the stock is going to fall. In order to realize your gains when the stock does go down is you buy back what you borrowed to cover your position. This is the legal way.

Naked short selling is simply short selling short but without borrowing the shares. This is the illegal way and this is what the US Securities and Exchange Commission is cracking down against. There were reports that the biggest victims of this practice have been Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE), the two biggest mortgage lenders to the American public. Others have been financial institutions like Lehman Brothers (NYSE:LEH). If you noticed, what's common with these stocks are they are all in the financial sector. This industry has been battered starting with the subprime problem, housing sector, and now every financial institution has been slowly reporting that they exposed too much money in the said areas. Fundamentally we know that's a recipe for disaster and that you would expect their shares to drop. But unfortunately, unscrupulous traders have taken it upon themselves to make money out of the situation without going through the proper channels.

It is for this reason alone, the US SEC is said to be imposing a one-month ban on short selling to prevent what could be a massive collapse in the sector which could spill over to the economy.

On the local front, the timing of the PSE seems to be impeccable. They're just about to introduce the short selling program as another tool to spur liquidity in the market. What timing indeed. It's like kicking a man when he's down. The market is already bearish and when this is now introduced, what's going to stop the shares from falling further?

To my knowledge, not all shares will be qualified for short selling. Only selected companies will be part of this. But I believe these are also index issues. There also seems to be a lack of education regarding this program for the investing public. Our investors/traders are not the most mature, some even qualify to be considered goons. So it's quite dangerous to allow these people access to short selling as they could just sell the shares without even thinking of buying it back at a lower price.

The timing of introducing short selling to the PSE is wrong. All investors & traders must be given a proper education about how to use this before it's launched. Otherwise, you could be looking at chaos right in the eyes and it will be translated to anarchy in the market.

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