Short selling declines as U.S. stocks scrape new lows

The effectiveness of the ban is in question - financial stocks underperformed the market for the entire duration of the ban until October 8, when it was lifted.

The recent decline in short calls, also reflected in numbers from Data Explorers Limited, suggests short sellers were not the cause of Citigroup's share slide.

Earlier this month, short calls on Citigroup were just 2.3 percent, Short Alert data shows. Data Explorers' figures indicate the number of stocks on loan - considered a proxy for short selling - was 1.8 percent last week.

Experts say traders have pared their short covers on fears that U.S. bailouts could trigger a rally in stocks that could wipe out their profits.

Further, the SEC has implemented emergency rules to crack down on so-called "naked" short selling, when traders sell short without borrowing the underlying stock, scaring off some short sellers.

"How greedy do you want to be?" said Bill Rhodes, chief investment strategist of Rhodes Analytics. "Do you want those last two to three points or do you want that thing to pop back in your face?"

Still, some investors welcome the addition of further layers of protection, saying short sellers would "get used to it," said Frederick Lipman, a securities lawyer with Philadelphia-based law firm, Blank Rome LLC.

But others lament the declining trend, arguing that if the SEC makes it harder to short stocks, the market was in danger of becoming overvalued.

"If you drive short selling out... recovery periods are much longer and more difficult, and the volume on the market is much thinner," Rhodes said. "It doesn't help stop selling."

(Editing by Kenneth Barry)