This morning’s news from AP is that the SEC has placed a temporary ban on short-selling stocks to curb falling prices. That’s been a favorite aggressive market maneuver by options traders for a while. I’m not a market expert, but I’ve got a little common sense, and this is a common sense move. Basically, short-selling works like this:

You think that stock in a certain company is going to go down in price. You don’t own that stock, but you want to profit from the drop so you put up shares of the stock for sale – even though you don’t own them. When the stock sells, your investment company fills the order by buying the stock at the current market price, and either charges or credits your account with the difference. If the price drops between the time you enter the sell order and the time the company has to fill the order by buying at market price, you make money. If it stays the same, you’re out the fees to the investment company. If the price goes up, you lose money – you have to buy the stocks at the higher price in order to fill the order that you placed to sell at the lower price.

It’s a risky move in most financial climates – except for one thing. When stock prices are dropping like mad, a flood of sell orders on the market will drive the prices further down because of basic supply-demand economics. The most of the stock is available to buy, the less people will be willing to pay to buy it, since there are so many other sellers out there.

In a normal market, buyers will step in when the prices near or breach a support level – a price where a stock has traditionally leveled out or started back up. This is not a normal market, though – major financial institutions are toppling and others all over the world are wobbling. The market is in panic-sell mode, so the buyers aren’t stepping in. And there are buyers out there, trust me. They’re waiting for the fire-sale prices to scoop up as much stock as they can afford in companies that will survive the crisis. These are the times when fortunes are made – not, as most people believe – when the market is on the upswing.

By stepping in to stop short-selling, the SEC is curbing one of the practices that forces prices down artificially. With the order in force, people will only be able to sell shares of stock that they actually already own. This will prevent an oversupply from pushing prices down further and sparking more panic selling which will depress prices further still which will – it’s like holding up a funhouse mirror to a funhouse mirror and watching the distortions warp things further and further from reality.

Right now, the ban covers only stocks in publicly traded financial companies, but the SEC is considering doing the same with other publicly traded stock. It’s going to be interesting to watch how the temporary regulations that are being put in place to shore up the failing economy will play out in the long run. After all, the federal income tax was only supposed to be a temporary emergency measure as well.

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