September 11, 2006	Monday	Sha'aban 17, 1427

MOST investors buy stocks much the way they buy houses.  They try to buy cheap and sell dear.  Some traders, however, try to accomplish the same thing in reverse order when they think a stock will decrease in value, they sell the stock first, in the belief that they will be able to buy it back at a lower price later.  This is known as short-selling. 

Short-selling can be a highly successful trading strategy for an investor who knows how to time his transactions and can recognise overpriced stocks before the general public does.  On the other hand, it can be highly risky.

Since there is no upper limit as to how high the stock being shorted can rise in price, the potential loss to the short-seller is infinite.  On the other hand, the investor who shorts a stock with advance knowledge of news that will cause its price to drop precipitously can make a killing.

Any economic decision by a person, which brings him gain, however great it may be, but that gain is at the cost of other members of the society, is irrational. Only those economic decisions where private interests coincide with social interests may be termed as rational.

Stock speculation/short selling is known to be extremely a risky trading method that can wipe out life savings overnight. While a risky method can produce fabulous gain in relative short-term, over the long run, a risky method is more likely to make people poorer rather than richer even if a short-term gain was gigantic.

Gigantic short term gain is just a dangerous stock market trap to lure the inexperienced people into the market. Dreaming for instant satisfaction of huge short-term gain overnight with speculation is just a recipe for disaster ahead. In fact, a long- term investment can obtain high performance with less risk.

Many individual investors got wiped out during March 2005 and May-June 2006 trauma. Short selling pushed the players to start liquidating and in the process small investors lost their shirts.

More than 90 per cent of individuals investors lost money in the stock market and created opportunity for the bulls. The truth is that only a small percentage of experienced people earned disproportionate huge amount of return many times at the expense of the rest through stock speculation.

Stock speculation is regarded merely as a game for the rich or as gambling for the brave. The investors confidence has been badly impaired in the prevailing conditions at the Karachi Stock Exchange.

The buoyant mood at stock markets that prevailed during fiscal year 2004 continued during the current fiscal year. The stock market witnessed extreme bullish and bearish sentiments during the period January-March 2005.

Despite sustained efforts made by the SECP to implement the reform measures at the outset of the year 2005, the extreme and abnormal volatility was witnessed in March 2005. The bull run in the stock market was triggered during January and it lasted for two and half months. The index closed at its all time high level of 10,303 on March 15, 2005.

However, a sharp decline commenced on March 16, 2005 resulting in the KSE-100 index declining by 25 per cent to a low 7,708 as on March 28, 2005. This was the fourth set back for the market over the past five years; previous setbacks were in May 2000, September 2001 and May 2002.

To avoid such crises and to ensure the preservation of market integrity, investor protection and the restoration of investor confidence, the SECP introduced risk management measures/reforms such as elimination of carry-over transactions (COT); introduced a comprehensive time-bound action plan to ensure the smooth phase out of the same subsequent to the close of the year 2005.

The Commission introduced a continuous financing system (CFS) as an interim measure to replace COT/badla financing and to enhance the level of liquidity in the market; initiated developing of alternative modes of leverage financing including margin financing and futures market; and incorporated the necessary measures into the CFS Regulations for the minimization of market abuse and the mitigation of risk. Accordingly, these regulations provided several crucial risk mitigating measures.

All trades were settled and market-to-market losses were collected in accordance with the regulations. The sanctity of the contract and integrity of the system were preserved.

Further, the institutional investors were back in the market after their traditional sojourn at the end of the calendar year 2005.The people were collecting shares in anticipation of reaping dividends and good capital gains once half-yearly and full-year financial statements hit the market by the end of January to mid-February.

The joyride came into full swing in mid- February 2006 when the KSE-100 index breached the barrier of 11053 points propped up by sound financial results and hefty dividends announced by some blue chips.

However, the bearish spell was short-lived. Despite implementation of all corrective reforms, the Commission could not vigorously pursue regulation measures so as to eliminate the conflict of interest on the boards of the stock exchanges which resulted in recent May-June 2006 market crash. Price sell-off as a result of heavy short sale was recorded at the KSE where the Index fell to 10,009 points on March 13, 2006 from 11474 points on March 1,2006.

After May 25, the bears became more aggressive and the KSE share index moved below the 10,000 mark on May 31,-2006. The KSE witnessed a highly volatile week between June 12 to 16 as the doomsday was observed on June 14, 2006 when a fall of 418 points in index and decline of market capitalization by Rs124 billion was observed.

KSE is still facing volatility in the stock market, over-speculation and impediments. The present situation of the market does not depict positive outcome of initiatives undertaken, post March 2005 and May-June 2006 crises. Apparently, the market crashed due to the same reasons on both occasions. This negates the Commission’s firm commitment towards ensuring investors’ protection.

However, strict adherence to the rules and regulations are strengthen and develop the legal framework, curb illegal and fraudulent business activities and enhance compliance of registered entities.

There is still a whispering about lifting of ban on short-selling in future contracts, as was earlier proposed by bourses from September 1 and turned down by SECP. If that happens, it is more likely to lead toward creating a mess and conditions for another crisis in the stock market.

Analysts are of the view that the decision to continue the ban would also help in generating healthy volumes and invite sideline investors to participate potentially in the market. Short-selling, if allowed, will hurt the investors. Nobody, including perpetrators of these malpractices, can escape from the fall out of their harmful effects.

The SECP should introduce regulatory policies to protect investors against manipulators.

However robust trading is possible and things can be improved mainly by the capital market reforms including development measures introduced and adopted by the stock exchanges with full support and guidance of the apex regulator, SECP.

The capital market reforms could help in restoring investors’ badly shattered confidence by promoting a fair, efficient and transparent capital market.