As watchdogs short sellers help protect investor interests

Chennai: As vigilant watchdogs, short sellers have a crucial role to play in maintaining the stability of financial markets. By keeping companies in check, they protect the interests of retail investors.

A short seller borrows shares of a stock they believe will fall in value, sell them in the open market, and later buy them back at a lower price to return to the lender. The difference between the sale and buyback price is the profit.

In order to make profits, short sellers find overvalued stocks of weak or vulnerable companies. They do not target overvalued companies that are well-run by the management. Instead, they target companies with multiple flaws, such as fraud, capital weaknesses, poor operations, or incompetent management.

By unearthing fraudulent activities and financial irregularities within companies, they alert the retail investors who are exuberant about the sky-rocketing prices of the stock.

Short selling forces companies to enhance transparency and accuracy in financial reporting and adopt a proactive approach to run the company well to avoid attracting short-sellers. When attacked, the shares of the company plummet and this forces the management to review their operations and policies and bring in changes. The presence of short sellers instils a sense of confidence in retail investors, improves shareholder value and protects their wealth.

Further, by exposing the irregularities in large companies they effectively bring overvalued stock prices back to a more reasonable level. This prevents the market from blowing into a bubble and reduces the risk of sudden, severe corrections. Maintaining market stability ultimately benefits all investors.

The retail investors also get an opportunity to buy the stock at reasonable prices if they believe that the company will course correct and recover the losses.

Moreover, in capital markets where the nexus between power centres and business houses is quite possible, short sellers can be instrumental in providing much needed checks and balances.