Short Selling

A reader requested a review of the trading methodology presented at TimothySykes.com (“Short Selling Penny Stocks”), which essentially uses price-volume analyses in attempts to detect in real time penny stocks being pumped and ride the ensuing downside (dump). Timothy Sykes, author of the An American Hedge Fund, is a former hedge fund manager and founder of BullShip Press LLC. His bio states: “Since the beginning of 2008, Timothy has been the #1 trader/investor, out of 25,000+ on Covestor.com.” Using the record of 296 trades spanning 2/1/08 through 1/22/10 (including those previously posted for October 2009, but now missing) and some recent clarifications from Timothy Sykes, we find that: Keep Reading

A reader asked about Phil Erlanger Research: the Art of the Squeeze Play for institutional investors, which offers “research focused on delivering…advanced technical and sentiment research and data,” and the companion Erlanger Squeeze Play for private investors, which identifies “short-term trading opportunities in both long and short squeeze plays.” The core elements of this research are “short intensity and technical strength.” The performance data on the two sites are identical, but more up to date at Phil Erlanger Research. Should investors expect that portfolios built on this research will substantially outperform the market? Based on weekly self-reported performance data and contemporaneous weekly data for S&P Depository Receipts (SPY) spanning 3/8/02 through 10/9/09, we find that: Keep Reading

A reader asked: “I am under the impression that stocks usually drop by the amount of the dividend on the ex-dividend day. Is this true…or more precisely, how true is this? If it is true, couldn’t one just short the stock on that day? If it is not true, could you just hold the stock for that day and reap the dividend? Also, could options be used to make some profits on this? Selling calls or buying puts?” Keep Reading

A reader asked: “I have never heard of a shorting method that outperforms bonds or stocks over a horizon of greater than 5 years. Do you know of any?” Keep Reading

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

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

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

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

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

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