Making money selling short challenges investors. Using exceptional research, short sellers pick the target, timing, techniques, and analytics to consistently produce short selling profits. And other investors can use the data, analytics, and research produced by short sellers! That information often helps investors gain market insights and company intelligence. And that helps both long and short investors improve their stock market vision and understanding.
What you learn:
Learn how real short sellers consistently make money. They do that by understanding and using short sale basics of research and data analytics. Short sellers build their timing, target and technique skills on that research to produce their exceptional record of success. by knowing the value of short data analytics, any investor can improve their stock market vision, understanding to become a more effective and profitable investor. This lesson helps give you some of these important insights.
FAQs investors asked about Making money selling short
How does selling short make money?
Investors usually make money by buying low to later sell high for a profit. Or they buy stocks that pay dividends to collect a steady income stream.
But short sellers are different. They research to find overvalued stocks with significant business problems. Then, when they expect the price to be ripe for a correction, they borrow shares from their broker's inventory to sell while prices are high.
Next, they release research showing why the overvalued price should fall. Once the price drops, they repurchase lower-priced shares and repay the stock loan to keep the price difference as profit. When done well, the profits are substantial.
Although it sounds simple, short-selling is a demanding and advanced strategy with significant risks and challenges.
Why is selling short bad?
Short-selling has positive and negative effects.
It helps control excessive market optimism and serves as a check on bad actors and underperforming companies to benefit investors and markets.
However, short-selling can also disrupt targeted companies and increase market volatility. That may be unpopular with targeted company shareholders and investors who don't understand it.
Short sellers borrow stocks to sell them at high prices and make a profit when they buy them back at lower prices, which is the opposite of the usual buy-low, sell-high strategy.
However, most complaints about short-selling address the symptoms rather than the underlying issues.
But, short selling can be overdone, cause excessive volatility or increase a price panic and prompt a temporary short-selling ban to settle markets.
What makes a successful short seller?
The best short sellers possess financial acuity, psychological strength, and a sharp intellect. Ultimately, their success hinges on analytical prowess and the courage to challenge the status quo.
Expert short sellers are not just traders or investors; these seasoned professionals leverage their extensive market knowledge and experience guided by rigorous research.
Their deep understanding of business operations and financing and an uncanny ability to spot signs of fraud or mismanagement help them identify potential issues and capitalize on short-selling opportunities.
What companies make the best short sale targets?
The best short sale targets are exposed frauds with overvalued shares!
A stock with multiple financial and operations issues can also be an excellent short sale target. Research reports about the company, competitors, and the market may uncover other business issues. Those can include financial mismanagement, money laundering, a price bubble, scarce resources, market failures, or obsolescence of products, services, or technology.
Good management avoids or addresses issues and problems; poor management does not. However, short sellers can get lazy, skip intense research, and simply short a volatile or high-priced stock. But those single-issue shorts are risky and are usually bad short sale picks. Most often, they become money-losing trades if there are no other problems.
Making a Successful Short Seller
A successful short seller has unique skills and qualities that differentiate them from typical investors. Here are the key attributes and strategies that contribute to their success:
1. In-Depth Research and Analysis
Thorough Investigation: Successful short sellers conduct extensive research and due diligence to identify overvalued stocks or companies with fundamental weaknesses.
Understanding Financials: They understand financial statements and are skilled at identifying red flags such as accounting irregularities, declining revenues, or unsustainable business models.
2. Risk Management
Risk Assessment: Short selling has significant risk, so successful short sellers are adept at assessing and managing these risks. They use stop-loss orders and position sizing to limit potential losses.
Hedging Strategies: They often employ hedging techniques to protect their positions and mitigate risks associated with market volatility and unexpected events.
3. Patience and Discipline
Waiting for the Right Opportunity: Patience is crucial in short selling. Successful short sellers wait for the right opportunities and do not rush into positions without thorough validation.
Sticking to the Plan: They maintain discipline by sticking to their research and strategy, avoiding impulsive decisions based on short-term market movements.
4. Market Timing and Sentiment Analysis
Timing the Market: While regular market timing is impossible, experienced, successful short sellers have a sharp sense of market sentiment when a stock price decline becomes probable.
Sentiment Analysis: They monitor market sentiment and investor behavior to identify overhyped stocks or when negative sentiment might drive a stock down.
5. Strong Analytical Skills
Technical Analysis: Proficiency in technical analysis helps short sellers identify entry and exit points for their trades.
Critical Thinking: They are critical thinkers who question prevailing market narratives and look for inconsistencies others overlook.
6. Emotional Resilience
Handling Stress: The potential for significant losses requires that successful short sellers have the emotional strength to manage stress and stay composed under pressure.
Staying Rational: They remain unswayed by market hype or fear, managing their emotions to make analysis-based logical decisions.
7. Regulatory Awareness
Compliance: Understanding and complying with regulations governing short selling is essential. Successful short sellers stay informed about regulatory changes and ensure their activities are within legal boundaries.
Navigating Legal Risks: They know and manage the legal risks associated with short selling to minimize them.
Consequences for Short Sellers
A successful short seller combines in-depth research, risk management, patience, market timing, analytical skills, emotional resilience, and regulatory awareness. These qualities enable them to identify and capitalize on overvalued stocks or companies with fundamental weaknesses while effectively managing the inherent risks of short selling.
A Guide to Identifying Short-Sale Targets
Good short-sale targets are companies with overvalued stocks or facing fundamental challenges that could lead to a decline in their stock prices. However, short-selling can be risky and speculative, and thorough research and analysis are essential before selling short. Characteristics that make a company a potential short-sale target include:
1. Overvaluation
Companies with overvalued stocks are prime candidates for short-selling. Those overvalued shares are essential for any short-sale target. High price-to-earnings (P/E) ratios signal potential bubbles, especially when compared to industry peers or historical averages. Such valuations without corresponding earnings growth can attract short-sellers looking to capitalize on a correction.
2. Frauds or Financial Mismanagement
Fraudulent activities or questionable financial practices are red flags for short-sellers. Frauds are prime short-sale targets. Aggressive accounting techniques, misleading financial reporting, or outright fraud can mask a company's underlying weaknesses. Finding discrepancies in financial statements provides valuable insights into a company's financial health.
3. Weak Fundamentals
Companies facing declining revenues, profitability, excessive debt, poor management decisions, or falling market share are vulnerable to short-selling. These fundamental challenges undermine the company's long-term prospects and may trigger a downward spiral in its stock price.
4. Sector-specific Challenges
Specific industries may face systemic challenges that make them attractive short-sale targets. For example, companies in sectors like retail, oil, or traditional media may struggle to adapt to changing market dynamics, creating opportunities for short-sellers to profit from their misfortunes.
5. Market Sentiment
Sentiment-driven fluctuations can create short-selling opportunities. For example, hype-driven stocks that experience rapid price increases without fundamental justification are particularly vulnerable to sentiment shifts. Short-sellers capitalize on these market dynamics by betting against overvalued stocks.
6. External Factors
External events such as regulatory changes, geopolitical instability, or macroeconomic trends can negatively impact specific companies or industries, making them potential short-sale targets. Short-sellers identify targets by closely monitoring these factors and quickly react to any lucrative trading opportunity.
7. Loss of Investor Trust
Activities that erode public trust and confidence in a company, such as scandals or unpopular decisions, can signal a potential short-sale opportunity. Investor sentiment plays a crucial role in driving stock prices, and short-sellers capitalize on negative sentiment to profit from declining share prices.
8. Legal and Regulatory Risks
Legal or regulatory scrutiny can harm a company's financial performance and stock price. Short-sellers closely monitor legal and regulatory developments to identify companies facing significant legal risks that may create short-selling opportunities.
9. Market Overreaction
Market overreactions to news or events can create short-selling opportunities. When shares experience excessive volatility or negative news triggers a sell-off, short-sellers capitalize on the downward momentum to profit from falling stock prices.
10. Reputational Damage
Reputational damage can have long-lasting consequences for a company's financial performance and stock price. Short-sellers exploit reputational crises to profit from declining share prices as investors lose confidence in the company's ability to generate returns.
Short-selling allows investors to profit from declining stock prices, but it's a high-risk strategy that requires careful analysis and risk management. Identifying suitable short-sale targets involves evaluating factors, including overvaluation, fundamental weaknesses, market sentiment, and external risks. By conducting thorough research and analysis, investors can identify lucrative short-selling opportunities and mitigate potential losses by employing risk management strategies.
Short sellers are exceptional traders
Short sellers make money by selling high and buying low to cover and pocketing the difference. But doing that effectively requires knowledge, skill, and a record of profitable trading. A consistently successful short seller is not your average investor!
Short sellers are exceptional in several ways. Obviously, they are skilled and experienced traders. But long before making any trade they apply exceptional knowledge and experience to excellent research and analytics. They do their homework and know what they are doing.
On their base of research and experience they carefully select and plan their timing, target and technique. Their research work and short selling activity produces a rich trove of information that all investors can use as additional data. But it must be used with good judgment. Although short seller research is often excellent, they are not in this for you or me! Use with care and caution!
Shorts, like all participants in the stock market cover the range from honorable and trustworthy to outright crooks and frauds. I eagerly use short seller research but never act on it without careful critical thinking about the source. Faulty and at times completely false work does get released. As always in the market, we have to be careful out there, especially when considering unconventional information.
Both long and short investors gain insight by analyzing short sale data
In fact, short-selling analytics and money-making insights go together. That means, all investors who pay attention to the short selling data can find valuable information. That information often directly applies to money-making opportunities. And sometimes the right data that increases your profit potential.
Analysis of short selling uncovers useful information
Experienced or novice, long or short, all investors can benefit from short selling analytics. And like all market activity, short selling leaves a trail of fresh data. By analyzing that information we may produce useful investing insights.
Stock exchanges make short selling statistics available to the public in regular reports. Those reports are typically posted on stock exchange websites twice a month.
That information provides both positive and negative market signals. For some investors the data indicates opportunity while others see the same information warning of trouble to come.
One thing remains obvious to everyone, the list itself of companies attacked by short sellers, is short. With relatively few companies on the list, most companies on a stock exchange have no shares sold short against them. For most listed stock exchange companies are completely held by long only investors with no short position.
Of the relatively few companies that have shares held in short positions, very few have short positions held against them for quarter after quarter. There are always exceptions, some epic short battles have gone on for years. Those are exceptionally rear.
However, most short battles play out over a few weeks or months. And, in general, relatively few companies ever have shares held in short positions.
Short selling numbers you need to know
Total number of shares issued
Number of shares sold short
Number of shares traded each day
The total number of shares issued by a company can range from a very few to over a billion. The typical public company has multiple millions of shares issued. The key information is knowing the total number of shares outstanding for each company of interest.
By itself the total number of shares issued means little. We need it and two more numbers, in order to compare the data. We also need the count or number of shares actually sold short, that lets us calculate some key information. With that information we can relate the number of shares sold short to the total number issued.
The short interest
The comparison of shares sold short to the total number of shares issued reveals the short interest. Normally that calculation gets reported as the percentage of total shares that are held short.
Short interest indicates the strength of the negative outlook on that stock. If say, selling 2% of the shares are short, that means 98% of the shares are long! The short sellers will need a good story or negative news to get much downside action with a 2% short position. By themselves they are not likely to cause much selling or even much interest.
Still, when any level of short selling is first reported, the least confident investors can spook and quickly sell. But unless the short interest grows, usually, little else happens.
However, when the short reports show 20% or more of the shares sold short, there certainly is much greater reason for concern. That 20% defines the lower end of larger short positions. Even if somewhat arbitrary, however, knowing of such short interests is certainly useful information. It gets wide attention for full-blown long-short battles.
Too much of a good or bad thing
Should the short interest get too high, a short-term bullish situation could be developing. Remember, the shorts have to cover or buy back the shares. Too many shares short and the negative selling pressure flips to become a strongly positive buying force. THE SHORT SQUEEZE!
A squeeze can happen when the short interest gets near or over 50%, the basic math begins to work against the shorts. Then, once buying back begins, a bear or short stampede can happen. The basic math goes strongly against the shorts. There simply are not enough shares for all the shorts to profitably cover. Dramatic price spikes quickly happen.
Days to cover the short position
The days to cover or short interest ratio is one more number that informs us. When we know the number of shares traded during a typical day, by dividing the total number of shares short by the average number traded, we learn the days to cover.
That short interest ratio or days to cover is the number of days of total trading volume the shorts need to cover, or buy back, and close their short position. The 50-day average number of shares traded is typically used.
That average reports the volume or number of shares traded over the previous 50 trading days. That gives us the average of 10 weeks or about 2 ½ months of trading volume history.
Using the 50-day average smooths out spikes or dips from any change in short-term or recent activity. That ensures any extra quiet or very active trading days do not skew the overall message or impression.
Compare only comparable numbers
Understand the numbers you use, especially when comparing between different stocks listed on different markets. Some exchanges report the number of shares outstanding and others use the float.
The shares outstanding are the total number issued. The float usually means the number held by the public.
However, there are variations in obtaining and reporting the float number. That leaves room for some creative numbers which can mean possible manipulations or oversights.
Some exchanges also give historical information as a measure of short interest. In my view, total shares outstanding provides the most reliable and comparable number. It is the only consistent and reliable number to use.
Whatever number you use, make sure that comparisons get made using numbers obtained in the same way.
What we know
We know that short sellers must buy back the shares sold short. Right or wrong in their strategy, they must repay the borrowed shares.
That opens the door to being right about a short but still losing money. At times shorts get it right in their business analysis and short strategy, but still lose on the covering trade. They can get squeezed at the buy back and see their profits quickly evaporate.
Most often, that happens when there are too many shares sold short. Thus, there are simply not enough shares to buy back at prices that allow all shorts to profit. Once that squeeze starts, a stampede to cover can rapidly unfold. Prices get driven up as all shorts attempt to minimize their loss.
Observers of short battles look for such bullish opportunities. They watch the days to cover as a key indicator. It points to the pending buying pressure that must come.
The more days to cover the greater the coming upside pressure. Possibly a very bullish sign. It can predict a coming short squeeze. Quickly buying long to have shares for selling to covering shorts at higher prices can produce much excitement and very profit.
But that is a very risky way to make money. This is not for new investors or beginners just learning to trade, under any circumstances.
Real short sellers make it happen
The best research is not doing and short sellers don’t profit from research. Rather, they must make the trade happen to produce profit. That is where the rubber meets the road! And that is when their timing, target and technique skills come into play.
Timing must be right on!
Remember short selling costs pile on by the day so being too early runs costs up cutting or eliminating possible profit. Being too late simply misses the opportunity which produces costs but no profit. Profitable short sellers have to get the timing right.
Target must be ripe for the picking!
There is an element of timing in target selection. Again too early or too late misses the profit. As well, experience plays a significant role is target selection. The short must bide their time while the target ripens or moves toward the short ambush. Likewise waiting for the sure thing may be far too late.
Technique has to measure up!
The actual execution into the short trade has to be as stealthy as possible. When the short position becomes known, everything can quickly change and that may change the opportunity as well. Beside short selling making a hands on demands of competence in trade execution, rapidly changing circumstances can demand quick decisions or a plan modification.
When entering the trade has been a success, the game is underway but not close to being over. Even when the market moves as the short expected, there is still no profit to take home. To take profit, the trade has to be successfully reversed.
Timing again comes into play. Leave too early and significant profit can be missed, leave too late and the market may wipe out any profit and impose unlimited costs. Shorts have to get out of significant positions and do it as quietly as possible to show the best returns. Technique matters.
Question Answered!
The lesson discussed how short selling makes money by selling high and buying low to cover low and pocketing the difference as profit. Short sellers build their timing, target and technique skills on a base of research base to produce their exceptional record of success. Short research data and analytics, improves stock market vision, understanding making investors that pay attention more effective and profitable.
Lesson takeaways,
Making money selling short:
Making money selling short needs the right timing, target and techniques built on exceptional research and analytics to develop trades that make money with consistency. Other investors can use the data, analytics and research produced by short sellers to gain insight and market intelligence. That can help both long and short investors improve their stock market vision and understanding.
Other lessons related to: Making money selling short
Investor homework grows profits
Dangerous dividend warning signs
Financial statement numbers exposed
Comments and questions welcome
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Short story shorting stocks:
Short selling stock explained Lesson 1
Short selling improves markets Lesson 2
Short selling improves companies Lesson 3
9 Short seller facts align Lesson 4
Making money selling short Lesson 5
Shorting stocks has risks Lesson 6
Who’s selling your stock? Lesson 7
Short seller skill sophistication knowledge Lesson 8
Short seller cost control Lesson 9
Short selling has rules Lesson 10
Next lesson 6:
Shorting stocks has risks
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