I understand what the actual process of doing so is, but for example I’ve seen people who work on wall street try to reassure us that it’s a normal and healthy part of wall street. I don’t understand how it’s allowed, or why any company would allow it to happen to their shares?
In: Economics
The theory goes something like this.
A company’s share price represents the value of the company. Having an accurately valued company is a good thing for the market and economy. An undervalued company is bad, an overvalued company is bad.
If you think a company is undervalued, you should buy shares on the basis that sooner or later other people will realise this and the price will go up. Buying shares also functions as a signal to the market and pushes the price up, so its closer to its correct value. Later on you can sell the shares for a profit (or hold them for dividends).
Following the same logic, if you think a company is overvalued you should sell any shares you have. But what if you don’t have any shares to sell? It makes no sense to buy shares just to sell them.
So what you do is you short them. This allows you to send a signal to the market that the price is too high, and help correct it.
That’s the theory, at least, as I understand it.
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