What is short-selling?

In the context of stock markets, short-selling is where an investor takes a position that the value of a given company’s stock will fall rather than rise.

How does it work?

Standard stock market trading works on the basis that shares will rise. You buy shares with a view that they will increase in value, allowing you to make money when you sell.

But what if you believe shares will drop in value? Buying shares you anticipate will fall in price is a sure way of losing money. Shorting allows you to “borrow” shares – generally from your stockbroker – which you then sell in the market.

At some point, you will have to return these borrowed shares. A short seller is betting they will be able to purchase the shares in the market at a lower price at this point, profiting from the difference.

Why have some countries introduced bans on short-selling?

European markets have swung wildly this week on rumours about the health and funding needs of indebted euro-zone governments, and more recently of some of its major banks, which have sent shares tumbling.

A number of governments involved believe that the markets are in danger of fundamentally damaging what they see as being stable, well-funded institutions.

And are they right?

Traders said yesterday that the ban did not tackle the main cause of investors’ concerns – lack of joined-up, long-term fiscal policy in the euro zone – and pointed out that nervous, mutual funds were currently behind the sell-off.

The ban is unlikely to stop the flight by institutional investors who have decided they have little stomach for big holdings in banks and indebted governments who might call on them again for emergency capital.

“Data from various regulators of late have shown there is no short-selling activity out of the norm,” said Davide Burani, financial analyst at Italian fund manager Horatius.

Who has banned short-selling and of what?

Following the failure of the European Securities and Markets Authority to agree a Europe-wide ban on Thursday night, a number of countries decided they would act unilaterlly.

France banned short-selling on 11 financial stocks for 15 days and Spain decided that it would protect 16 stocks for 15 days.

Belgium banned short-selling of four financial stocks for an indefinite period.

And Italy said that its ban covered 29 companies in the banking and insurance sector.

Will it work?

This is not the first time that short-selling of financial stocks has been banned. Following the collapse of Lehman’s bank, many European governments and the US Securities And Exchange Commission introduced such restrictions.

Germany, among others, has several times triggered such bans since then. Short-selling of listed Irish banks has been forbidden since the Lehman’s crisis, for all the good it has done.

With the bans in place for only two weeks, investors said relief for bank stocks would be temporary in the absence of co-ordinated action by Europe’s governments

(Additional reporting, Reuters)