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Naked Short Selling (NSS) basics.

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Blinton   Friday, 05/28/10 08:33:33 PM
Re: Blinton post# 13
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Naked Short Selling (NSS) basics.


I recommend reading up on Short Selling before trying to understand Naked Short Selling:

Quick Explanation

Naked short selling, or naked shorting, is the practice of short-selling a financial instrument without first borrowing the security or ensuring that the security can be borrowed, as is conventionally done in a short sale. When the seller does not obtain the shares within the required time frame, the result is known as a "failure to deliver".

Is Naked Short Selling Even Legal

Naked short selling is illegal in most cases. Many countries have outlawed the practice. And even in the countries that still allow naked short selling, it is only permitted under specific circumstances.

In theory, if you are a market maker who needs to provide shares for a stock which is lacking sellers, then you can temporarily and legally naked short sell to create liquidity and stability in the marketplace. And even then you're supposed to give your word that you'll obtain the required shares as soon as possible, and at the very least within a set timeframe, otherwise you're violating the law.

Possible Abuse and Manipulation

In recent years, a number of companies have been accused of using naked shorts in aggressive efforts to drive down share prices, sometimes with no intention of ever delivering the shares. These claims focus on the fact that the practice allows an unlimited number of shares to be sold short.

An overly-simplified explanation is that naked short selling enables abusers to drive down a company's stock by offering an overwhelming number of virtual shares. These companies generate overabundant supply, thus depleting demand, resulting in the stock price artificially drifting downward. And to add to the mess, these unnatural downward shifts can also create confusion and fear in the long stock holders resulting in a snowball effect as they prematurely exit the stock. All the while, the naked short sellers illegally make money hand over fist as the price falls.

Mass naked short selling can be devastating to micro-cap stocks where volume and market cap are low - making them prime targets for manipulation. The manipulators can play the odds because micro-cap typically fail more often than not. And over time they've also created a playbook of nasty tricks to help drive down a healthy stock rise after the manipulators have become over leveraged in an unexpected losing short position.

To Be Continued

There is a lot more to Naked Short Selling than this, and we'll eventually go into much greater detail. But for now that's all you'll need to know as far as the basics are concerned.


* http://en.wikipedia.org/wiki/Naked_short_selling
* http://www.investopedia.com/terms/n/nakedshorting.asp

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