MYTH: Short sellers are pessimists who want the markets to drop.
FACT: Many short sellers use market-neutral strategies, consist of both long and short positions simultaneously.

The idea that short sellers are a bunch of naysayers hoping for a massive market swoon is a common misperception. Many if not most short sellers are also buyers on the long side, using strategies like long/short equity or arbitrage to attempt to achieve returns that are independent of overall market performance.

MYTH: Short sellers hurt the profits of long investors by reducing the price at which they sell their stocks.
FACT: Short sellers help to reduce long investors risk of buying overvalued stocks, and provide liquidity to the market.

While short sellers can potentially reduce a stock's price, long investors also benefit from purchasing stock at a reduced price. The market participants that truly feel the affect of short sellers are those who (1) sell stock that they don't purchase on the open market, and (2) attempt to sell at a price that short sellers find excessive. Examples of these market participants are investment bankers and company insiders who obtain shares directly from companies and who promote and/or exaggerate a company's prospects so they can make more money on the backs of other investors.

Further, the extra trading volume that short sellers add to the market provide additional liquidity and helps to lower the built-in trading costs of bid-ask spreads.

MYTH: Short sellers reduce companies' access to capital
FACT: Short sellers shrink the amount of capital invested in overpriced companies, leaving more capital for fairly-priced companies

When short sellers reduce the price of an overvalued stock, the capital that would otherwise have been invested in that company can then be allocated towards other investments.

MYTH: Short sellers openly trash good businesses
FACT: Most short sellers prefer not to disclose their positions

While from time to time an activist short seller will crop up who publicly denounces the firms they are shorting, most prefer to keep their positions secret so that others do not become aware of their strategies and compete for the same opportunities. And in the instances of deception and scandal, such as with Enron and Tyco International, activist short sellers like James Chanos' public disclosures help to root out and discourage dishonest management, which in the long-term protect shareholders' interests. Pepperdine University Economics Professor Gary M. Galles wrote an excellent article defending the merits of short selling and its overall benefits to a healthy, efficient market.

MYTH: Short selling is Un-American
FACT: Moves to restrict short selling are Un-American

OK that's an opinion and not a fact. But consider: Is it American to have financial markets in which only people who have positive opinions about stocks are allowed to participate? Is it American to have financial markets in which insiders and investment bankers get to promote securities without any third-party checks and balances to moderate their prices if they become excessive? Not to me. This country was founded on principles of free speech, and of checks and balances in power. A market which doesn't embody these fundamental American ideals is fundamentally Un-American. Selling short helps make prices more accurate, make markets more efficient, ferrets out fraud and mismanagement, and provides a counterbalance to Wall Street's widespread bullishness.

For me, that makes short selling as American as apple pie.

About the author: Steve Smith is a professional investor with a portfolio containing both long and short investments.

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