Do we need short-sellers in the market?

Short-selling

It's one of the way of investing in stocks. When considering about long position investing, investors expects the stock will rise in the future and secure the stocks until the price rise in the future. Mostly, they buy value-growth stocks for betting future rises. Short selling is an opposite concept with the usual method. Investors predict the price of a stock will fall and bet against it, earning gains with inverse direction to the long. 

Process

Investors borrow shares in current price, sell them in the market, and return them back in the future. That is why they hope the market to be transacted in lower price so they can pocket the difference. For example,

1) If a person A is deciding whether to buy the shares of a specific company. By analyzing the firm's fundamental, A expects the sales of the company will fall down which will lead to the fall.

2) The person A borrows the company stock from lenders or brokerage firms, and sells in the price of $100 (which is market current price).

3) As expected, the share drops about half which makes $100 into $50. Then investors buy the share again in $50.

4) The investors returns the stock back to the broker. Then the investors gain the gains of $50.

Success stories in short-selling

During the financial recession in 2008, Michael Bury (movie Big Short) was betting against housing market rise, predicting the bubble would collapse resulting to sharp drop of securities. He made great wealth by a huge amount of short selling (buying CDS) which later made into massive returns. It is about 489% return ($2.69 billion in total). Other than that, George Soros made substantial profit betting against the rise of British Pounds and Italian Lira. 

Do we need short-sellers in the market?

Yes, absolutely. Those forces take essential part in the stock market. They can stabilize the capital market being overpriced or over-heated (bubble). They also can provide liquidity to function the market smoothly. Moreover, short-selling companies scrutinize meticulously whether the company honestly reports their earnings or not, which leads on positive effect on corporate's transparency on their financial statement. For example in the beginning of this year, Muddy Waters started shorting Luckin Coffee, one of the biggest coffee chain firm in China. They found out the possibility of accounting fraud in the company, which later let the world know about the scandal.

Lets be careful

Short-selling can be effective to earn gains only if the investors have strong conviction to the market's direction. Timing is also most important basis that short-sellers need. I read the article related to it in Wall Street Journal. I want to share part of the story: 

Mr. Kullamägi, who has been speculatively investing about a decade has been enjoying himself on volatile stocks for betting against the rise. One day, he captured the prey for his bets on Eastman Kodak's fall in July. When the government announced to grant $765 million loan for Kodak for supporting to make vaccine against Covid-19. The stock had threefold rise, and Mr. Kullamägi thought that the Robinhoods (mom-and-pop investors) will push the shares of Kodak higher, but would not last long. He tried to short 45,000 stocks partially until July 29th, but accidentally clicked the wrong button to double the short amount all of 90,000 shares at once which lead more cost. The shares rose seven times more and he was "stuck for the ride". He has made $1.5 million in his expenses for the trade cost.

Investors like to gain their profits by any method. It is not only individuals but also applies to the big firms like Softbank and Berkshire Hathaway. The method can be differed since there are various types of betting, however lets be careful before we put into the movements.

Source: Short Selling Stocks Proves Costly for Some Investors

https://www.wsj.com/articles/short-selling-stocks-proves-costly-for-some-investors-11599645600?mod=mhp