Short Selling

…evidence does not support a belief that “buying stocks when they begin trading OTC is a profitable strategy.”

…evidence indicates that short sellers are on average skilled public information processors, successfully discriminating between future underperformers and outperformers, with exploitation concentrated after several categories of news releases.

…evidence from simple tests on available data supports a belief that Timothy Sykes can identify pump-and-dump patterns in real time with economically meaningful consistency, but scalability is multiply constrained such that his subscribers may not be able to mimic his trades reliably. Niche constraints may preclude exploitation by large traders, a large group of small traders and funds.

…available data is insufficient to determine whether Phil Erlanger’s Research is exploitable on a net basis. Portfolio overhead and biases in self-reported hypothetical returns could offset reported gross market outperformance for most investors.

The net of this research appears to be that only very low-cost traders (such as market makers) can effectively exploit the anomaly.

The valuation-based method described in “Modeling the Logic of Valuation-motivated Short Sellers” is a candidate…

…evidence from simple tests on a limited set of data offer little support a belief that changes in aggregate short interest reliably predict future stock market behavior. There is an example in the sample period of a materially disruptive single observation (Black Swan?).

…evidence indicates that short sellers are on average able to identify both overvalued and undervalued stocks. Investors/traders may be able to exploit the economically large positive future returns of lightly shorted stocks with simple long-only strategies.

…investors/traders may be able to earn significant abnormal returns by following the lead of short sellers when the short sellers disagree with expert equity analysts (short sellers know best).

…short sellers have acted as specialized monitors who tend to know what they are doing, but high levels of and large positive changes in institutional ownership can obscure short interest informativeness.

…removal of the tick test for short selling apparently: (1) mitigates overvaluation of stocks; (2) leads to temporary undervaluation of easily borrowed stocks; and, (3) disrupts trading systems that rely on dispersion of analyst earnings forecasts.

…investors can concentrate the informed signals of short sellers by locating stocks with high short interest and low institutional ownership, and an increasing ratio of short interest to institutional ownership.

…fundamental analysis (especially accrual-related indication of poor earnings quality) helps valuation-motivated short sellers identify stocks likely to experience reversal of strong past returns.

…unusual trading by insiders helps isolate which short sellers know what they are doing, and vice versa.

…it appears that some short selling is manipulative, seeking to scare other traders out of their holdings during sharp but temporary engineered price drops.