Beware When Shorting Stocks

Over the course of the longest bull market in history contrarian investors have again and again predicted doom and gloom and been burned again and again. As noted in the movie “The Big Short,” there are times when shorting a stock can be immensely profitable. But, choosing what to short and timing of when to do it are keys to making money with this approach. Unfortunately for contrarian investors, in the last year the “most shorted stocks” went up as a group more than twenty percent! So, you should beware of shorting stocks. But, many shorts in the last year were successful! How can you profitably pick and choose?

Beware When Shorting Stocks

Market Watch visited the issue of Wall Street’s most shorted stocks in a recent article.

With U.S. stocks up around 25% so far this year, it would appear to be have been a tough year for short sellers. But a breakdown of the most shorted large-cap stocks indicates Wall Street’s nabobs of negativity have enjoyed a somewhat more upbeat story.

In a Tuesday note, analysts at Bespoke Investment Group observed that Russell 1000 RUI, +0.24% stocks with more than 20% of their float sold short have seen total returns of 14.81% so far in 2019. That’s a solid gain, though it lags the returns of more than 25% posted by large-cap indexes, including the S&P 500 SPX, +0.22% , over the same time. That means shorts “have done OK on a relative basis,” the analysts wrote.

The least-shorted stocks in the index are up 31%, so there was some predictive value to looking at what was being shorted and what wasn’t as a group. But, within the “shorted” group there were some big losers! Here are some examples from the list of stocks that had more than 20% of their float shorted.

  • US Steel, -22.68%
  • Range Resources Corp, -59.50%
  • Nordstrom Inc., -15.25%
  • Macy’s Inc., -44.72%
  • Wayfair Inc., -4.65%
  • Bluebird Bio Inc., 24.65%
  • Macerich, -32-97%
  • AMC Networks Inc., -29.06%
  • 2U Inc., -51.61%
  • Grubhub Inc., – 44.15%
  • Sarepta Therapeutics, -0,68%
  • World Wrestling Entertainment, -18.93

Timing When Picking Stocks to Short

Although we repeatedly remind investors that fundamental analysis and appraisal of intrinsic stock value are essential for investing in stocks, that approach is best used for long term investing. The issue when shorting a stock is that you are borrowing money to buy the stock with the expectation that you can, rather quickly, buy it back at a much lower price. A good example is Match Group which was the most heavily shorted stock in this list at 59% of its float. The stock is up 61.37% on the year. But, it is down 19% in the last three months and 4% in the last month. If you shorted this stock at the beginning of 2019 you got burned and if you shorted it three months ago you are riding high. In short, you need to stay abreast of market sentiment and short term factors when shorting stocks because you cannot afford to hold onto a short and constantly pay interest for years and years while you wait for your predictions to work out.

How to Pick Stocks to Short

Those who are successful at shorting stocks track their target stocks and are fully aware of the intrinsic value of these investments. Then they decide what to look for, the trigger, that will make them short the stock. Although shorting stocks can be vastly more profitable than investing in them long term, timing and appreciation of market sentiment are crucial factors for success.

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