The Real Deal Behind Short Selling: It's Not What You Think

Want to know why short selling gets so much hate? Most people think it tanks stock prices, but the data tells a completely different story.

Here’s what’s actually happening:

Who’s Really Shorting?

Spoiler: It’s mostly not those “evil hedge funds” everyone fears. The majority of short selling is done by market makers and arbitrageurs — basically the plumbing of markets. They’re:

• Market makers: Provide constant buy/sell prices, sometimes holding a short position for minutes before closing it
• Arbitrageurs: Exploit tiny price differences between related stocks or ETFs (transferring liquidity, tightening spreads)
• Options traders: Hedging positions dynamically

Dedicated short-only funds? Less than 1.3% of all hedge fund activity.

What Does the Data Actually Show?

• Short positions are stable: They don’t spike during market crashes (contrary to fear)
• Median short interest: Around 5% or less of shares outstanding per sector
• Daily short trading volume: ~40-50% of all trades (consistent with intermediary activity)
• Fails are rare: 75% of stocks have ZERO share fails on any given day; total failing shares = <0.01% of market cap

The reality? Most shorts close out within hours or days, not weeks.

Why Does This Matter?

Academic research is unanimous: short selling improves markets. It:

• Tightens bid-ask spreads
• Increases liquidity
• Improves price accuracy
• Lowers capital costs for companies

Historically, when countries banned short selling, liquidity dropped and spreads widened — prices still fell anyway.

The Regulatory Guardrails

U.S. regulators already put rules in place:

• Reg SHO: Bans naked shorting, requires stock borrowing
• Uptick rule: When a stock drops 10%, shorts can’t sell below ask (no new lows)
• Buy-in rules: If settlement fails for >1 day, brokers must buy to cover
• Threshold lists: Stocks with persistent fails require pre-borrowing

Bottom Line

Short selling isn’t the villain in the story — it’s the supporting cast keeping markets efficient. The real action? Long selling actually drives stock prices down more than short selling does. So the next time someone blames shorts for a crash, ask for the data.