The customer must pay all interest charges during the period of sale, as well as all premiums that the broker may have to pay in the process of borrowing securities on the market. The lender of the stocks— not the short-seller who is borrowing the stocks—gets all the dividends that they pay. The broker cannot terminate his loan of securities to the customer when ever he desires, and if, after he borrows from another member of the Exchange, his loan is called in, he must replace it in some way or other.
In regard to interest on the proceeds of the short sale, no definite, clear-cut custom has been adopted. As a rule, no interest is allowed; but where large trans actions are involved, special arrangements are made for the distribution of interest charges between the two parties. In the case of the margin that the customer advances, however, no question arises, since it is taken for granted that interest will be paid him on this sum.
8. Market effects of short selling.—In any normal market there is always a considerable "short" interest; in other words, there are a considerable number of per sons who are selling stock short in anticipation of a decline. There is likely to be a considerable "long" interest at the same time; that is, it is likely that there will be a number of persons who have bought stock in anticipation of being able to sell it at a higher price. The conflict between these two interests, together with the influence exerted by those who buy outright, is the force which largely fixes the price of securities. A very active long interest,—the purchase of stock in large amounts will force prices up. On the other hand, large short sales result in heavy offers, and buy ers can sometimes be found only when the price con cessions have been secured. When, however, the market is dominated by either one or the other interest, a reaction in the prices of stocks will usually follow immediately.
The hammering of the prices of securities, caused by constant short selling, drives prices so low that the bulls see a chance to make an advance. Their efforts are frequently aided by the outside buyer, who figures that the existing price of the security offers him a de sirable investment. The buying done by these two parties in the transaction immediately absorbs all the stock that the shorts offer. As soon as this movement
begins—in fact, sometimes before the price of the se curity has been advanced—the short interest "scram bles to cover," buying in stock to close up their trans actions.
9. Dangers and the advantages of short selling.— Short selling is dangerous for the seller unless there is plenty of stock available for borrowing purposes. This is because lenders of stock can call in their loans at any time. Thus the short seller may be faced with ruin unless there is another lender ready. As a matter of fact, loans of stock are constantly being called in, renewed or placed with other lenders.
Short selling is safe only when the stocks that are sold have a large "floating supply"—in other words, only when a large proportion of the outstanding stock is available for speculation, instead of being locked up in the vaults of investors. The only kind of stock which it is really safe to sell short is that which is constantly in the hands of brokers and actually en tered, in their names, on the company's books. For many years United States Steel, common, was such a stock, because most of it was held by brokers, in their own names, for customers who had bought it on mar gin. The largest lenders of stock are brokers, and the stocks that are most available for lending are those which brokers hold on margin for speculators.
Preferred stocks, choice investment stocks and those that are very high-priced are not suitable for selling short. When shorts cannot borrow stocks at all, a corner exists. Corners are described in detail in Chapter XIX.
10. Loaning rate as a market index.—Attempts are often made to judge the condition of the market by the extent of the existing short interest as reflected in the demand for loans, which in turn is shown by the rate charged. But conditions in the "loan crowd" are misleading for a number of reasons, the most im portant of which—a curious one—is the following. Many sellers of stocks, in order to conceal their opera tions, actually borrow in the loan crowd, and then when the time comes to cover their short contract, deliver their own stocks out of their strong boxes. This is true of corporation directors and others who do not wish to have it known that they are selling out.