The term "short" has been in use since at least the middle of the 19th century and refers to the deficit position that a short seller has with their brokerage firm. The practice has been around for centuries and has often been used a scapegoat when financial markets are going through a difficult period.
The first recorded instance of short selling is believed to have occurred in 1609 when a merchant arranged short sales on stocks of the Dutch East Indies Company VOC which was listed on the Amsterdam stock exchange. This also prompted the first attempt to ban the practice. In 1610, directors of the company persuaded the government to declare shorting illegal as bearish speculators were "incommensurably damaging innocent shareholders, among which are widows and orphans". Illegal short selling continued anyway, so in 1689 the Dutch government imposed a tax on profits from the activity.
A similar pattern recurred in 1720 in Great Britain when the speculative South Sea Bubble burst. Shares in the South Seas Company jumped from 325 pounds to 1200 pounds as merchants rushed to acquire the rights to trade with Latin American countries. When shares in the company later fell to just 86 pounds short sellers got the blame. A law banning short selling was introduced in 1734, but as it was never applied it was repealed in 1860.
New York state unsuccessfully banned short selling in 1812 following heavy speculative activity that occurred at the outbreak of war with England but was repealed during the 1857-59 depression. The US government tried to rein in short selling in 1864 with the Gold Speculation Act, however in just two weeks the price of gold rose from $200 to nearly $300 and the ban was lifted.
Bank failures and panic in the British financial markets in 1866 was blamed on short selling and a law was passed forbidding short sales on banking shares. Once again the law was never used and testimony to a Royal Commission in 1868 showed that the problems had been caused by irresponsible banking practices and poor asset quality.
Short selling continued throughout the 20th century, but so did the animosity toward its practitioners. In 1929 such was the fury of ruined shareholders that one short seller had to hire bodyguards.
The very first hedge fund employed short selling as part of its strategy. Established in 1949 by Australian-born Alfred Winslow Jones with $100,000, the fund combined long positions on undervalued shares with short positions on overvalued shares. The early 1980's saw the creation of the first companies that specialising in short selling, and hedge funds with focus on the practice became more attractive after the stock market crashes of 1987 and 2000.
It remains to be seen whether the regulatory reaction to recent market hysteria is any more successful than previous attempts to curtail short selling.
