There are several misconceptions and doubts about shorting, and whether it has any direct impact on the stock price. So, does shorting a stock make it go down?
In this article we will look at the consequences of shorting a stock, and whether it can force the stock price to decline.
Can shorting a stock make the stock price go down?
Shorting a stock can definitely have an impact on its price, however, it depends on a few factors:
- Liquidity
- Volume
- Float
- Number of shares shorted
Liquidity
The liquidity of stock can determine whether its price goes down or not when it is shorted. An illiquid stock or thinly traded stock can collapse if there are enough shares shorted in a short period of time.
Therefore, illiquid stocks, especially penny stocks can have drastic price movements as a consequence of heavy short selling. While thinly traded stocks can be affected by short, the same does not happen with larger companies with millions or billions of shares traded daily.
Volume
The volume of the stock traded can also influence whether the stock goes down when shorted. Every stock has an average traded volume, which represents the average number of shares traded every day. Although on some days the stock might have a lower volume, and in situations where the volume is low, a heavy short seller could push the stock price lower.
Float
The float is determined by the percentage of outstanding shares that can be traded on the open market. Certain companies that have high insider ownership naturally have a lower float. The low float means that there are lower shares to be traded on the open market. If the float of the company is just 20% of the outstanding shares it becomes easier to influence the price of the stock by shorting.
Number of shares shorted
Finally, one of the most important factors to consider whether or not shoring a stock makes it go down is the number of shares shorted. A large number of shares shorted in a small period of time can drastically affect the bid-ask spread, and size, and influence the price directly.
Additionally, if investors are not keen on investing in the stock a high volume of shorted stock can drastically affect its price. If there are buyers ready to buy the stock, then shorting might push the stock price just slightly down.
How does shorting hurt a stock?
As we have seen shorting a stock, especially when its liquidity and float are low, can directly push the stock price down. This ends up hurting the stock and affecting current shareholders. If there isn’t enough interest from investors in acquiring additional shares the stock can continue to decline until short sellers decide to cover their shorts.
Lenders of the shares can also push the stock price higher if they demand a forced share recall, which forces short sellers to buy back their shares, and could lead to a short squeeze.
What happens when a stock gets shorted?
When a stock is shorted the short sellers borrow the shares and sell them in the open market, promising the lender of the shares to return the same amount of shares.
What happens is that when a stock is shorted the number of shares increases, and this is why sometimes the short interest can be over 100%.
This exact situation happen during the GameStop saga, which marked a rebellion of retail investors against hedge funds.
How long can short sellers keep a stock down?
While short sellers can have a negative influence on the stock price, it is crucial to understand exactly how short selling works. Whenever a stock is shorted, the short sellers sell those shares to an investor. As long as investors are willing to pay a lower price for the stock, the stock price will continue to decline.
Short sellers can definitely have an influence on the stock price, but they cannot artificially push the stock down and keep it around certain price levels.
Can shorts manipulate a stock?
While it is possible to manipulate a stock, especially penny stocks through short selling, in reality, this is extremely difficult to accomplish. Either the investor or the group of investors needs to control a sizeable chunk of the company’s float, and this requires a lot of capital in order to be done successfully. Additionally, this also puts them at risk of a short squeeze, which can be instigated by a share recall, which will force short sellers to cover their positions.
The idea of a short ladder attack on certain stocks is more of a Wall Street myth than anything else.
Conclusion
It is certainly possible for short sellers to push the price of a stock down, however, it is not as simple as it looks. Pushing the stock price momentarily down, as other market participants adjust their bids, and volume of the stock is certainly possible, but doing it over a long period of time becomes increasingly difficult.
Additionally, trying to keep the price of a stock down by shorting poses a tremendous risk of a short squeeze that could make short sellers lose a lot of money.