The Chicken Littles of the Market

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Photo – stockphototops.blogspot.com

“Hey you! Yeah you! Don’t look behind yourself. I am talking to you. I have an offer to make. But I don’t have a good Marlon Brando impression so you can refuse if you want to. You want to invest in the markets? No? Why? Because you are not sure that the share will go up. Well are you sure that it will go down? Good. Then why don’t you short the market? Don’t back away. Why are you running? It’s a good deal.”

I think hearing the word short or shorting the stock would get the same reaction from 9 out of 10 people. Shorting the stock is like saying I feel the company will lose value in the near future. Based on low sales, high costs, bad management or the Mayan’s prediction coming true in 2012 and there being a run on the company.

Basically I am rooting for the company to fail just like I would bet on a horse to lose rather than win. Your cringing makes me feel that you do not like the idea too much either. But sad to accept it is because of them that markets do work. Imagine that Apple is going to be listed in UAE. Now if everyone feels that the company is going to do well (prelaunch of the new iPhone), everyone would like to hold the shares and no one would be selling. Everyone is buying which should be great. But it isn’t because who is selling in this case. There need to be people who are willing to take the other perspective and sell to these buyers to enable the sale to take place. So first of all, there need to be people who are willing to go against the market based on their own expectations.

The second point in favour of the shorts is the fact that if I have only buyers or sellers in the market, I do not know the actual price of the asset. I want to sell a piece of land or even if I have a land that is similar to the one that is being advertised, I would want to know what the price of my land is. I see that there are 10 sellers who are willing to sell from $1,000 to $10,000. Which is the correct one? I don’t know unless a buyer comes along and wants to buy it from me. It is the price that he quotes that will give me my limits and bounds and allow me to evaluate the price of the asset in the end. So by having shorts, it allows us to have a system of price discovery in the market to determine the price that should prevail in the end.

Lastly, let’s say that I am a farmer. I grow crops and do the whole nine yards. Now what if I work for 6 months on my field and by the time the crop actually grows, the price of wheat has fallen compared to when I started. It would be a waste of my time, energy and would lead to a loss. What I can do is when I am going to grow the crops; I can short the wheat by selling it before hand and locking in a price. I can sell it to someone who expects it to grow and lock in the price that protects my profit. This would be beneficial for me.

What I am trying to do here is trying to be the devil’s advocate. The whole world wants progress and go forward but I have a pessimistic view of reality. While others look at the sky and see rainbows and butterflies, I look up and can’t help but shout “the sky is falling! The sky is falling!” My point is that there is place for everyone in the financial markets and that we need both sides in order to function properly and to lead to more efficient markets. What was that saying about sausages being made?

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