Michael Steinhardt, one of the pioneers in the hedge fund industry once said that he probably has shorted more stocks than anyone else and when he looks back cumulatively at all his shorts he probably broke even on them.
Here are some of the rules I have when it comes to shorting;
1. Don’t short oversold markets; the market has a history of bailing out the bulls, not the bears. Currently, we are somewhat oversold, and you might hear that oversold can become more oversold, but the odds always favor a dead cat bounce than an outright crash. I still prefer cash over shorting when the market is oversold.
2. Don’t short an index that already is down multiple days in a row; indices tend to mean revert.
3. Now and then you might get lucky shorting an oversold market that becomes more oversold and stays oversold, but the distance between now and then is huge. Don’t do it.
4. Do not short a stock that is down multiple days in a row, wait for the dead cat bounce (3-5 days) then short preferably with some of the moving averages above the price of the stock.
5. Do not overstay your welcome on the short side; the biggest rallies happen in bear corrective markets.
6. Shorting is very enticing due to the fact six months worth of gains in a stock could easily be wiped out in a matter of days, look at the oil names, biotechs, and the SP500 in the couple of weeks. However, all the stats are against you so do it selectively and at the right time. In the last 89 years, stocks have closed down 20% or more six times, 6.7%. 35 out the 89 years stocks delivered 20%+ returns, 39.3%. Timing is crucial.
7. Shorting a fundamental story is different than shorting something technically.
8. Shorting the so-called “leaders” that have broken down tends to be very profitable, focus on those. There is a stat that states that 80% of the biggest winners at one point lose 50% of their gains and 50% of them lose 80% of their gains.
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