Are short spread bets wicked?

European regulators have vilified the short seller as the root cause of the recent volatility in the markets. Here, Tim Bennett gives three reasons why a ban on short selling is complete nonsense - and why you should be prepared to trade both ways.

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Desperate to be seen to be doing something, regulators in Europe have tried to ban short selling of certain stocks. In a nutshell, they don't like hedge funds making money from falling prices and even accuse them of exacerbating downward moves. The implication is almost that there is something wicked about making money when prices fall. But anyone thinking of becoming a spread better and therefore able to make money from falling, not just rising, prices shouldn't let this type of argument put them off. Here are three reasons why.

For starters, criticising people who make money in a falling market while turning a blind eye to those who make a killing in a rising market is inconsistent. If regulators were so worried about share price falls, they would not allow bubbles to form in the first place. Low interest rates and quantitative easing have happily pushed up asset prices in the share and commodity worlds to frothy levels in the recent past. So it is simply bizarre for a regulator to get upset when prices start falling back to earth. Indeed, picking on anyone who wants to make money when prices fall smacks of scouting around for a scapegoat on which to pin central bank and government policy failings.

Next, spread betters do not mismanage companies the people who run those companies do. You sometimes hear management teams trying to pin blame on those shorting their shares as though without speculators all would be well. But if a share is overvalued, the faster it is brought back down to earth the better. Take the banks a short selling banresembles trying to support institutions that deserve no protection from the full force of the market for past lending errors. The faster those errors are fully exposed, the better in terms of getting the sector back up and running properly again. They simply can't bury bad news forever. Of course the directors will moan all their share options are suddenly at risk as prices fall. That's no reason to get stroppy with sellers it sounds like shooting the messenger.

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My third argument is that anyone betting on prices falling actually brings liquidity to the markets. It takes two to tango when it comes to trading buyers and sellers. By making life difficult for sellers, regulators reduce liquidity (the ability to trade) across the board. That in turn increases volatility. And I can't think why they'd want to do that right now.

Tim Bennett

Tim graduated with a history degree from Cambridge University in 1989 and, after a year of travelling, joined the financial services firm Ernst and Young in 1990, qualifying as a chartered accountant in 1994.

He then moved into financial markets training, designing and running a variety of courses at graduate level and beyond for a range of organisations including the Securities and Investment Institute and UBS. He joined MoneyWeek in 2007.

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