After another week of turmoil on the Australian stock market, the Australian Securities and Investment Commission has announced a temporary ban on 'naked' short selling. This action has been taken in an effort to restore confidence to the market - particularly the shares of those companies operating in the financial sector.
Rumour has it that hedge fund short selling was behind the plunge in the Macquarie Group (MQG) share price during the week. The stock hit a low of $25.98 on Thursday before finishing up the week at $35.90. It's believed short sellers targeted the stock in the wake of more bad news from Wall Street amid the Lehman Brothers collapse and the sale of Merrill Lynch.
Short selling is the practice of selling securities you don't own in the hope of buying them back at lower prices and pocketing the difference. It can be quite lucrative when the share price of a company drops a long way very quickly. The problem is that short selling exerts further downward pressure on the stock price and naturally leads one the ask questions about stock market manipulation.
I have read that Westpac and ANZ Bank have also been subject to pressure from short selling and this is where it can become dangerous. A plummeting share price can cause doubts in the minds of bank customers - not just investors. In the worst case scenario a run on funds could ensue. Deposit holders assuming there is something fundamentally wrong with the bank withdraw their funds en masse leaving the institution with a massive liquidity problem.
Only naked short selling has been disallowed. Covered short selling is still allowed (this is where you need to 'borrow' the shares before you sell it).
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