Blog - Investing Notes
August
2, 2005 – Short Sellers: Contrarian or Momentum Traders?
In the July 2005 update of their paper entitled "Can
Short-sellers Predict Returns? Daily Evidence", Karl Diether, Kuan-Hui
Lee and Ingrid Werner examine recently available daily short sales data
to test whether short-sellers trade with or against the trend and whether
they can predict future returns. Using the SEC-mandated tick-by-tick
short-sale data for 2,815 Nasdaq-listed stocks from the first quarter
of 2005, they find that:
- During the period examined, short sales represented
about 25% of total Nasdaq volume with only a fourth of this activity
from options and equity market makers (exempt from short-sale rules).
Since monthly short interest for the same period is only 3.3% of shares
outstanding, most short-selling must be short-term, perhaps intraday.
- Short-sellers are on average contrarian. They decrease
their short-selling activity following negative abnormal returns and
increase their short-selling activity following positive abnormal
returns. However, a a significant fraction of retail traders are likely
momentum traders.
- Stock prices decline significantly the day following
increased short-selling activity and significantly thereafter up to
day three. Small trades are most predictive of future returns.
- A trading strategy based on daily short-selling activity
generates significant returns, but incurs costs large enough
to wipe out any profits. A long-short trading strategy based on daily
small-sized shorting activity quintiles generates a monthly positive
abnormal return of 3.9%. Overall short-selling activity generates
significant positive abnormal returns for small-cap stocks, stocks
with low institutional ownership and stocks with no put options.
- Appearance on the Regulation
SHO threshold list suppresses subsequent short selling, but it
does not significantly affect future returns for stocks priced $5.00
and above. However, stocks on the threshold list priced below $5.00
do have significantly lower future returns.
-
There is no evidence that current short sellers have private information
about future earnings surprises.
In summary, very recent data suggests that short
sellers on average are contrarians who predict (or trigger?) near-term
stock price underperformance. However, the underperformance is economically
insignificant as a statistical indicator due to transaction and carrying
costs. The authors note that this study is based on a sample limited
in duration and scope.
For related research, see
Blog Synthesis: Short Selling and Short Interest.
