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Rules for Shorting Stocks

Recs

19

February 04, 2011 – Comments (5) | RELATED TICKERS: OPEN.DL , CRM , RLD

As someone who rarely shorts stocks in real-life, but enjoys doing so here in CAPS I found the following post that Barry Ritholtz just made about his personal rules for shorting stocks over at The Big Picture very interesting.

I always get burned by rules #1 & #2 here in CAPS, as you can see from my -89.69% return on my OPEN short, my -40% return on my CRM short, and my -39% return on my RLD short.  Fortunately none of those are real-life positions ;).

Here are the rules. Enjoy:

Rules for Shorting

1. Shorting Momentum names is dangerous: Unless you are Superman, never step in front of a speeding locomotive

2. Valuation alone is insufficient reason to get short a stock — History teaches us that cheap stocks can get cheaper, dear stocks can get more expensive

3. ALWAYS work with a pre-determined loss – either a physical or mental stop loss — Never leave yourself open to infinite losses

4. Fundamentals tell you WHY to short something, not WHEN to short it. ALWAYS have some technical confirmation before shorting. Make a short selling wish list, then WAIT for technical confirmation. (We use Money Flow, Short Term Trend lines, Institutional Ownership, Analyst Ratings).

5. It is tough to be a contrarian: During Bull and Bear cycles, the Crowd IS the market.

You have to figure out two things:
…a) When the crowd is wrong — Doug Kass calls it “Variant Perception”
…b) When the crowd starts to get an inkling they are wrong

At the turns — not the major trends — is where contrarians clean up.

6. Look for Over-owned, Over-loved stocks: 95% Institutional ownership, All buys or Strong Buys (no sells), and 700% gains over the past few years are reasons to put names on your short selling wish list. (That is how my partner Kevin Lane found and shorted Enron and Tyco back in the 1990s).

7. Beware the “Crowded Short“– they tend to become targets of the squeeze!

8. You can use Options to either juice your short returns, or pre-define your risk capital (options)


http://www.ritholtz.com/blog/2011/02/rules-for-shorting/

Deej

5 Comments – Post Your Own

#1) On February 04, 2011 at 3:54 PM, chk999 (99.97) wrote:

This is top notch!

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#2) On February 04, 2011 at 4:29 PM, russiangambit (29.16) wrote:

I am also greatful I don't have real life positions in LULU and GMCR.

However, these rules for shorting wouldn't save you from shorting LULU or CRM , for example.

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#3) On February 04, 2011 at 4:49 PM, russiangambit (29.16) wrote:

Well, I reread the rule  and I guess the first rule - don't short momentum plays is the answer to my question. However, all the unreasonably valued over-loved stocks are momentum plays, this is how they get where they are. So, if not these then what to short? The trick with momentum plays  is to figure out when they are breaking down for real, it make tke 2-3 years of wait and many headfakes , though. Shorting is dangerous business no matter what,

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#4) On February 04, 2011 at 5:25 PM, Bays (30.14) wrote:

I just stay away from shorting altogether! Mainly because of rule #2.

The market can stay irrationale for long periods of time.

Another great post, TMFDeej.

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#5) On February 05, 2011 at 9:46 PM, diditbad100 (< 20) wrote:

I also stay away from shorting, would have been a good idea for my caps rating if I had done so there as well!

great post-- I have too many times thought a stock was way over priced and over valued--only to watch it take off and double or triple!

HOG< WFMI< just to name a few.

 

 

 

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