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Dubai Financial Market said on Tuesday that it would introduce covered short-selling, a long-awaited move that is expected to give a major fillip to trading liquidity. Short selling, which allows investors to make gains in a falling market by borrowing a security they don’t own, selling it and agreeing to buy it back at a lower price, plays a critical role in developed capital markets since it makes price discovery more efficient and smoothens volatility while providing investors with a host of risk-management tools.

The DFM, the Gulf’s only listed stock exchange, said it would allow short selling on a selected list of eligible securities in accordance with international recommendations under local market conditions in the coming months, subject to regulatory approvals of its rules. “Introduction of short selling on the DFM is clearly a welcome step towards its alignment to the global financial markets and to boost liquidity in the markets. When we have traders/investors trading both ways, the trading activity increases.

Short selling is already available on the Dubai Gold and Commodities Exchange where a large number of clients are trading the Indian stocks, Indian rupee, fold, silver and currency futures.

“However, short selling is controversial because when a large number of investors decide to short a particular stock, their collective actions can have a dramatic impact on the company’s share price. Many companies will blame short sellers for sharp declines in their stock,”

Ban on short selling had been enacted on several occasions. “If there are large short selling positions, sudden attempt to square off the sell positions can also push the stock prices up artificially. Short selling also means unlimited risk if the stock prices increase rapidly. The regulators, exchanges and brokers would have to prudently watch for such activities,”

In 2012, the UAE’s financial regulator followed the lead of Kuwait, the oldest established stock exchange in the region, by authorizing stock lending and short selling, but restricted their adoption by limiting them to licensed market makers.

However, in part due to a concern about causing instability, the two UAE bourses have been delaying its implementation.

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