In a recent paper for the Royal Bank of Scotland Research Institute, two teams of economists compared the performance of different indicators as the market moves on a daily basis (and then also monthly).
One team looked at how different factors like short and long positions (called volume, or the number of times these traders were making a trade in a day) impact the performance of other factors.
The other team looked at the trading volume of all different types of traders, and how their trading compares with what each of these traders would see in the market. (In a typical short or long trade, the amount of cash that would normally be involved in making the trade – for example, in a buy or sell call option on a stock – would be reduced by selling the trade and buying shares on the stock – in essence buying the shares from the buyer or seller for a less than the price they would have paid for the stock or at the point of sale, and selling it again).
Both teams have found that, on a daily average basis, a trader who makes three large long deals (three times the amount of cash they used to buy shares) would tend to gain more from short positions than a trader who makes one short deal. But that’s the exception rather than the rule. Indeed, those traders who use three long deals are usually those who are trading with a long position and do not trade directly. (Short trading with a short position and the use of long positions is not a recommended strategy for most traders.)
One aspect of short-selling is that you can often buy shares without trading (or make trades with) the shares at all, and short sellers sell shares even without making a short position. So you can gain from holding for days or weeks while you wait for the market to rise.
In the paper, the authors say that it took about 13 days for the market to rise to $80 from $56. The reason for the rise was that there were no short-sellers with short positions at $80, and short sellers with long positions had bought a bunch of shares and sold them at an even higher price (at the second peak of the trading cycle). The authors conclude that:
We find little evidence for a negative correlation between stock volatility and price volatility. It is important to note that volatility is not causally related to price volatility or to long or short trading activities.
And they conclude:
There is significant scope for the equity market to improve its liquidity by increasing
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