Can anyone explain to me what constructive function short selling serves in a marketplace?
I can understand the purpose that futures serve - originally created to allow producers to plan and hedge, and speculators are happy to take on that risk and sit on the other side of the trade.
I can understand the purpose of various derivatives, again to serve a hedging purpose and thus provide a useful function for everyone from producers to portfolio managers to investors etc.
But I can not see what function shorting serves.
Also I do not understand how the shorting process can be justified as legitimate trading activity by the markets that allow it.
To short a stock you first need to 'borrow' that stock from another holder.
You then 'sell' that borrowed stock - now in my language if you are selling something that isn't yours then its not yours to sell, so how is this allowed suddenly in the stock market and considered valid. Then to pay back the 'borrow' you close the short position by buying back stock. The flaw is, in theory there would be a situation that you cannot actually return the borrowed stock because there's none left to purchase. Thus the word 'borrow' is a misnomer to my thinking and a better way of expressing it would be that the lender is actually transferring title to the stock with an agreed timeframe for equivalent stock to be transferred back from the borrower.
Consider a company that has three shares on issue. Holder A has 1 share. Holders B and C also have 1 share.
Mr E comes along and borrows Mr A's 1 share and 'short' sells it to Mr C.
In a few days Mr E wants to buy back 1 share to return the 'borrow'. But nobody wants to sell at any price - B and C both steadfastly hold and will not sell at any price. This means Mr E CAN NOT return the 'borrowed' stock. Thats because he actually sold something that wasn't his. So when reduced to fundamentals like this the word 'borrow' is actually technically incorrect. The stock has really been transferred ('sold') with an agreed price and timeframe for it to be returned. (transferred from lender to shorter for $0 with an agreement the lender will transfer equivalent stock back to lender for $0 in an agreed timeframe).
I've asked this question once before on another thread - but where does borrowed stock used by shorters actually come from, and do the holders of that borrowed stock actually know their stock is being loaned for shorting purposes?
Also why would anyone lend their stock to somebody that is going to push the price down? (perhaps because you want to buy more yourself?). What benefit is there in that and shouldn't the lender reap some benefit from this exercise as well?