Adani vs Hindenburg: What's short selling? Are bears the monsters?

A US short-seller, Hindenburg Research, with only a dozen employees, devastated Asia's richest and the world's third-richest man Gautam Adani in less than two weeks.

Following the activist research firm's investigative analysis report that was published on 24 January, the Indian port-to-power conglomerate Adani Group's nine major firms' market value more than halved – from $234.71 billion on 24 January to $115 billon on Thursday, according to CNBC.

Now, its Chairman Gautam Adani is not even on the list of the world's richest twenty men, according to Forbes and Bloomberg.

What Hindenburg did was find the loopholes in the Adani stocks' rally that brought $100 billion of Adani Family's $120 billion wealth in just three years, and effectively betting against the rally.

What Hindenburg did?

Hindenburg did not sell a single Adani shares, instead bet against Adani shares using US derivatives.

The lower the Adani shares go, the more Hindenburg makes.

Hindenburg also published a detailed report on the weakness of Adani shares alongside accusing the group of fraud, market manipulation and other malpractices.

How investors reacted

Adani shares suffered continuous selloff in the Indian bourses following the Hindenburg report and its confident announcement of short selling.

If no other investor lent an ear to the Hindenburg research report, Hindenburg would not make money and perhaps would incur losses in the trade.

What is short selling?

The question of how to effectively bet against a stock when the rest of the world keeps partying relates to short selling.

Unlike the most common style of investing – buying low, selling high to book the capital gains and waiting for the stock to come down again, short-sellers love to actively profit from the decline.

Short selling is the act of borrowing shares from others and selling them in the market with a hope that they can be bought cheaper later.

In simple words, a short-seller sells borrowed assets holding a compulsion to return the asset to the actual owner later.

If the price comes down after being sold short, the short seller makes money and vice versa, if the price goes higher, the short seller has to spend more to buy it from the market to return the exact number of stocks sold short to the actual owner.

Short selling started with the history of markets

Short selling has been around since the stock markets emerged in the Dutch Republic during the 1600s. In 1610, the Dutch market crashed, and Isaac Le Maire, a prominent merchant, was blamed because he was actively short selling stocks.

In the 1907 and 1929, Wall Street bubbles that burst at the extreme, legendary speculator Jesse Livermore shorted the market heavily and earned a lot.

In the 1987 bubble and black Monday crash, during the 1999-2000 tech bubble burst, in the 2007 US housing bubble, and the recent technology stocks bubble, crypto and NFT bubbles, everywhere short sellers bet against the market and the cheering crowd who consequently incur losses after the collapses.

Why short sellers are hated

Everyone who loses money, naturally, curses short sellers.

Even some experts blame short sellers tagging as the devastators or enemies of progress and wealth creation.

This is a battle among the bulls and bears in the markets over centuries.

Bulls believe the market should go higher and the bears feel no asset should go much higher than their intrinsic value.

Are bears the monsters?

Whatever the losers say, the global financial system and regulators do not buy it all.

How collective irrational exuberance pushes markets dangerously higher and the collapse from the sky financially devastates the blind bulls – the financial history has tons of evidence.

Short-sellers are the bearers of red flags during errant parties in the markets when irrational exuberance takes asset prices too high compared to their fundamentals and we all know the longer the undeserving rise continues the more devastating it proves for the average investors and the financial markets.

Even without the action of short sellers' at the market peaks, bubbles burst. For example, the 2010-11 market crash in the Dhaka Stock Exchange.

Regulators across the world, except for a very few underdeveloped markets cautiously welcome and allow short selling in predetermined asset classes. They also keep an eye so that syndicated short selling cannot hurt the system and savers.

Debates on how much short selling should be regulated and deregulated are there, but short sellers' role cannot be denied outright. 

Risks of short sellers  

Also, short selling is riskier than the traditional buy low sell high investments and that is why legendary investor Warren Buffet does not sell any stock short.

He says short sellers' risk is unlimited as one may have to buy back a stock at a theoretically infinite high price as there is no upside limit, while a bull at best may end up with losing the invested capital only. Stock price cannot be less than zero.

Is short selling legal in Bangladesh?

The Bangladesh securities regulator has formulated the short selling rules several years back. However, a poor market infrastructure and a lack of knowledge are yet to make short selling legal here. 

Globally, market infrastructure got so rich that Hindenburg did not need to come to India with its money and bet against Adani in the Indian bourses.