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Short Selling

Are there reliable paths to success in short selling? Is short selling activity a useful indicator for investors/traders? Does it mean “stay away” or “squeeze coming?” These blog entries cover the short side of the market.

Long Play When Shorts Are Away?

The conventional wisdom is that short sellers are on average more informed than other traders, and high levels of short interest in a stock indicate poor future returns. Is the converse true? Do short sellers stay away from good stocks? In the May 2009 version of their paper entitled “The Good News in Short Interest”, Ekkehart Boehmer, Zsuzsa Huszar and Bradford Jordan investigate whether the absence of short selling is informative about future returns. They base their investigation on three lightly (heavily) shorted portfolios that include stocks from the 1st, 5th and 10th (90th, 95th and 99th) percentiles of monthly short interest ratios (SIR), along with three related long-short portfolios. Using monthly short interest, returns and firm characteristics for NYSE, AMEX, and NASDAQ stocks from 1988 to 2005 (930,109 stock-month observations), they conclude that: Keep Reading

Combining Short Interest and Analyst Recommendations

Are short sellers and expert equity analysts generally in synch or out of synch? What does it mean when short sellers and analysts disagree? In their September 2008 paper entitled “Trading Against the Prophets: Using Short Interest to Profit from Analyst Recommendations”, Michael Drake, Lynn Rees and Edward Swanson investigate whether investors/traders can earn abnormal returns by trading on information provided by expert sell-side analysts (recommendations and recommendation changes) and short sellers (short interest). In their tests, they rebalance portfolios quarterly, hold for six months and adjust returns for firm size. Using a large sample of quarterly return, short interest and analyst recommendation data for the period 1994-2006 period, they conclude that: Keep Reading

The Interplay of Short Interest and Institutional Ownership

Does the power of short interest to predict future returns derive from superior information of short sellers or from overvaluation driven by short-selling constraints? In their January 2008 paper entitled “Why Do Short Interest Levels Predict Stock Returns?”, Ferhat Akbas, Ekkehart Boehmer, Bilal Erturk and Sorin Sorescu examine evidence that discriminates between the competing information and overvaluation explanations. Their key discriminators are: (1) the effects of levels of and changes in institutional ownership (availability of shares for shorting) on the predictive power of short interest; and, (2) the relationship between short interest and subsequent news. Using daily stock returns, monthly short interest, quarterly institutional holdings, firm fundamentals and news/earnings reports spanning 1988-2005, they conclude that: Keep Reading

Implications of Short Selling with No Tick Test

The SEC originally adopted Rule 10a-1 (the tick test) for listed securities in 1938 to restrict short selling in a declining market. After a test commencing 5/2/05 involving about 1,000 “pilot stocks,” the SEC removed the tick-test rule for all listed securities effective 7/3/07. Does this rescission change the equity valuation landscape for U.S. equity investors/traders? In an October 2007 paper entitled “The Tick-Test Rule, Investors’ Opinions Dispersion, and Stock Returns: The Daily Evidence”, Min Zhao investigates how the removal of the tick test changes the effect of short selling on stock prices. Using SEC Regulation SHO daily short selling data, along with associated daily return and firm fundamentals data, for the period May 2005 through December 2005, the study concludes that: Keep Reading

Concentrating the Superior Knowledge of Short Sellers

Why does high short interest indicate future underperformance of stocks? Does the reason suggest a way to refine the short interest signal? In their October 2007 paper entitled “Why Do Short Interest Levels Predict Stock Returns?”, Ekkehart Boehmer, Bilal Erturk and Sorin Sorescu employ two distinct methods to determine which of two hypotheses drives the underperformance of heavily shorted stocks: (1) constraints on short selling, or (2) superior private information of short sellers. These methods combine the level of short interest with the level of institutional holdings (supply of shares available for lending) and with earnings surprises. Using return, short interest, institutional ownership, earnings and related fundamental data for a broad sample of stocks over the period 1988-2005, they find that: Keep Reading

The Logic of Valuation-motivated Short Sellers

Can analysis of firm financial data reliably identify future underperformers? Reader Mike Long of Short ALERT suggested for review a “paper that reverse engineers the short recommendations of an independent research firm into a model for selecting good short candidates” (disclosing that the research firm is Short ALERT). In the April 2007 draft of their paper entitled “The Role of Fundamental Analysis in Information Arbitrage: Evidence from Short Seller Recommendations”, Hemang Desai, Srinivasan Krishnamurthy and Kumar Venkataraman investigate whether analysis of company financial data reveals good shorting candidates. They first create a model of shorting demand by correlating company financial data for 1997-2004 with 54 valuation-motivated short sale recommendations from 67 reports issued by an independent research firm during 1998-2005. They then test the model out-of-sample (1990-1996) for a larger set of companies. Using the 67 reports, company financial data for 1990-2004 and monthly stock return data for 1990-2006, they conclude that: Keep Reading

Using Insider Trading to Find Informed Short Sellers

Conventional wisdom says that both short sellers and corporate insiders are typically better informed than most traders. However, much short selling comes from programmed (uninformed) hedging, and much insider trading is pre-planned diversification of concentrated positions by firm executives. Is there a way to overlay the activities of these two groups to isolate truly informed trading? In their July 2007 draft paper entitled “Shorts and Insiders”, Amiyatosh Purnanandam and Nejat Seyhun investigate the combined power of unusual levels of short interest and unusual insider trading to predict stock returns. They test for “unusual” short interest and insider trading by subtracting the historical mean from the current value and dividing this difference by the historical standard deviation on a firm-by-firm basis. Using monthly short interest, insider trading and stock return data for all NYSE/AMEX-listed firms during 9/91-12/03, they find that: Keep Reading

Shark Attacks?

Do some short sellers employ sharp intraday attacks on targeted stocks to trigger temporary plunges, during which they cover at a profit? In the March 2007 draft of his paper entitled “Predatory Short Selling”, Andriy Shkilko examines empirical evidence of such behavior. Using all trades and quotes in Nasdaq-listed stocks during regular trading hours from April 2005 to April 2006, he identifies 1,482 potential predatory attacks and concludes that: Keep Reading

Three Questions on Naked Short Selling

Is naked short selling a problem? The incentives for it seem direct and strong, while both regulation and enforcement against it seem weak. Just getting the facts about its extent is problematic. Here are three relevant questions: Keep Reading

Risky Stocks + Short Sellers = Low Returns

Do short sellers avoid highly volatile stocks, and thereby leave them overvalued? If so, when short sellers do attack volatile stocks, is the level of overvaluation therefore compelling? In the August 2006 update of their paper entitled “Costly Arbitrage and Idiosyncratic Risk: Evidence from Short Sellers”, Ying Duan, Gang Hu and David McLean test the hypothesis that short sellers tend to avoid stocks with high idiosyncratic risk because of the high cost of hedging such risk. Using data for stock prices, short interest levels and other factors spanning 1988-2003, they find that: Keep Reading

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