Is short selling necessary for the normal functioning of the stock market?
While short selling is often vilified during bear markets, there are many benefits that short selling provides to the normal functioning of the capital markets. SunGard Astec Analytics has completed several studies on the effects of short selling and the conclusion we have reached is that short selling increases liquidity and actually reduces volatility in the stock market. Without short selling, investors who believe that asset prices have increased too much are not able to make their opinion heard in the markets. This can lead to a bubble, which can eventually lead to disastrous effects on the entire economy. In other words, short sellers help keep prices in check and reduce irrational exuberance on the upside and also soften the landing on the downside. As was stated in the technical definition above, short sellers sell shares to begin the short sale process and naturally exert negative price pressure, but they must eventually close out their short position and buy equivalent shares
