Making money selling short needs the right timing, target and techniques built on exceptional research and analytics to develop trades that make money with consistency. Other investors can use the data, analytics and research produced by short sellers to gain insight and market intelligence. That can help both long and short investors improve their stock market vision and understanding.
How does short selling make money?
Short Story Shorting Stocks course, Lesson 5, answers the question, how does selling short make money? At the end of the lesson, links to related content help you learn more.
What you learn:
Learn how real short sellers operate to consistently make money. The lesson gives you insights into the importance of short sale basics of research and data analytics. Short sellers build their timing, target and technique skills on that research base to produce their exceptional record of success. Knowing the value of short data analytics, can improve your stock market vision, understanding and make you more effective and profitable investor.
Short sellers are exceptional traders
Short selling makes money by selling high and buying low to cover and pocketing the difference. But doing that effectively requires knowledge and skill. Consistently successful short sellers are not your average investor.
Short sellers are exceptional in several ways. Obviously they are skilled traders but long before any trade they apply exceptional knowledge and experience to excellent research and analytics. They do their homework and know what they are doing.
On their base of research and experience they carefully select and plan their timing, target and technique. Their work and short selling activity produces a rich trove of information all investors can consider using. I say consider because, although short seller research is often excellent, they are not in this for you or me.
Shorts, like all participants in the stock market cover the range from honorable and trustworthy to that outright crooks. I eagerly use short seller research but always with critical thinking. Faulty and at times completely false work does get released. We have to be careful out there, especially when considering unconventional information.
Both long and short investors gain insight by analyzing short sale data
In fact, short-selling analytics and money-making insights go together. All investors who pay attention to the short selling data can find valuable information. Often it directly applies to money-making opportunities. Extract the right insights from the data and increase your money-making potential.
Analysis of short selling uncovers useful information
Experienced or novice, long or short, all investors can benefit from short selling analytics. Like all market activity, short selling leaves a trail of data. Analyzing that information can produce useful investing insights.
Stock exchanges make short selling statistics available to the public in regular reports. Typically, data gets posted as reports on stock exchange websites twice a month.
That information provides both positive and negative market signals. To some investors the data indicates opportunity while others see the same information warning of trouble to come.
One thing remains obvious to everyone. The list itself of companies attacked by short sellers, is short. Relatively few companies are on the list. Most companies have no shares sold short against them. Most companies listed on most stock exchanges are completely held by long only investors with no one holding a short position.
Of the relatively few companies that have shares held in short positions, very few have short positions held against them quarter after quarter. There are always exceptions, some short battles go beyond a year.
However, most short battles play out over a few weeks or months. And, in general, relatively few companies ever have shares held in short positions.
Short selling numbers you need to know
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Total number of shares issued
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Number of shares sold short
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Number of shares traded each day
The total number of shares issued by a company can range from a very few to over a billion. The typical public company has multiple millions of shares issued. The key information is knowing the total number of shares outstanding for each company of interest.
By itself the total number of shares issued means little. We need it and two more numbers, in order to compare the data. We also need the count or number of shares actually sold short, that lets us calculate some key information. With that information we can relate the number of shares sold short to the total number issued.
The short interest
The comparison of shares sold short to the total number of shares issued reveals the short interest. Normally that calculation gets reported as the percentage of total shares that are held short.
Short interest indicates the strength of the negative outlook on that stock. If say, selling 2% of the shares are short, that means 98% of the shares are long! The short sellers will need a good story or negative news to get much downside action with a 2% short position. By themselves they are not likely to cause much selling or even much interest.
Still, when any level of short selling is first reported, the least confident investors can spook and quickly sell. But unless the short interest grows, usually, little else happens.
However, when the short reports show 20% or more of the shares sold short, there certainly is much greater reason for concern. That 20% defines the lower end of larger short positions. Even if somewhat arbitrary, however, knowing of such short interests is certainly useful information. It gets wide attention for full-blown long-short battles.
Too much of a good or bad thing
Should the short interest get too high, a short-term bullish situation could be developing. Remember, the shorts have to cover or buy back the shares. Too many shares short and the negative selling pressure flips to become a strongly positive buying force. THE SHORT SQUEEZE!
A squeeze can happen when the short interest gets near or over 50%, the basic math begins to work against the shorts. Then, once buying back begins, a bear or short stampede can happen. The basic math goes strongly against the shorts. There simply are not enough shares for all the shorts to profitably cover. Dramatic price spikes quickly happen.
Days to cover the short position
The days to cover or short interest ratio is one more number that informs us. When we know the number of shares traded during a typical day, by dividing the total number of shares short by the average number traded, we learn the days to cover.
That short interest ratio or days to cover is the number of days of total trading volume the shorts need to cover, or buy back, and close their short position. The 50-day average number of shares traded is typically used.
That average reports the volume or number of shares traded over the previous 50 trading days. That gives us the average of 10 weeks or about 2 ½ months of trading volume history.
Using the 50-day average smooths out spikes or dips from any change in short-term or recent activity. That ensures any extra quiet or very active trading days do not skew the overall message or impression.
Compare only comparable numbers
Understand the numbers you use, especially when comparing between different stocks listed on different markets. Some exchanges report the number of shares outstanding and others use the float.
The shares outstanding are the total number issued. The float usually means the number held by the public.
However, there are variations in obtaining and reporting the float number. That leaves room for some creative numbers which can mean possible manipulations or oversights.
Some exchanges also give historical information as a measure of short interest. In my view, total shares outstanding provides the most reliable and comparable number. It is the only consistent and reliable number to use.
Whatever number you use, make sure that comparisons get made using numbers obtained in the same way.
What we know
We know that short sellers must buy back the shares sold short. Right or wrong in their strategy, they must repay the borrowed shares.
That opens the door to being right about a short but still losing money. At times shorts get it right in their business analysis and short strategy, but still lose on the covering trade. They can get squeezed at the buy back and see their profits quickly evaporate.
Most often, that happens when there are too many shares sold short. Thus, there are simply not enough shares to buy back at prices that allow all shorts to profit. Once that squeeze starts, a stampede to cover can rapidly unfold. Prices get driven up as all shorts attempt to minimize their loss.
Observers of short battles look for such bullish opportunities. They watch the days to cover as a key indicator. It points to the pending buying pressure that must come.
The more days to cover the greater the coming upside pressure. Possibly a very bullish sign. It can predict a coming short squeeze. Quickly buying long to have shares for selling to covering shorts at higher prices can produce much excitement and very profit.
But that is a very risky way to make money. This is not for new investors or beginners just learning to trade, under any circumstances.
Real short sellers make it happen
The best research is not doing and short sellers don’t profit from research. Rather, they must make the trade happen to produce profit. That is where the rubber meets the road! And that is when their timing, target and technique skills come into play.
Timing must be right on!
Remember short selling costs pile on by the day so being too early runs costs up cutting or eliminating possible profit. Being too late simply misses the opportunity which produces costs but no profit. Profitable short sellers have to get the timing right.
Target must be ripe for the picking!
There is an element of timing in target selection. Again too early or too late misses the profit. As well, experience plays a significant role is target selection. The short must bide their time while the target ripens or moves toward the short ambush. Likewise waiting for the sure thing may be far too late.
Technique has to measure up!
The actual execution into the short trade has to be as stealthy as possible. When the short position becomes known, everything can quickly change and that may change the opportunity as well. Beside short selling making a hands on demands of competence in trade execution, rapidly changing circumstances can demand quick decisions or a plan modification.
When entering the trade has been a success, the game is underway but not close to being over. Even when the market moves as the short expected, there is still no profit to take home. To take profit, the trade has to be successfully reversed.
Timing again comes into play. Leave too early and significant profit can be missed, leave too late and the market may wipe out any profit and impose unlimited costs. Shorts have to get out of significant positions and do it as quietly as possible to show the best returns. Technique matters.
Question Answered!
The lesson discussed how short selling makes money by selling high and buying low to cover low and pocketing the difference as profit. Short sellers build their timing, target and technique skills on a base of research base to produce their exceptional record of success. Short research data and analytics, improves stock market vision, understanding making investors that pay attention more effective and profitable.
Lesson takeaways,
Making money selling short:
Making money selling short needs the right timing, target and techniques built on exceptional research and analytics to develop trades that make money with consistency. Other investors can use the data, analytics and research produced by short sellers to gain insight and market intelligence. That can help both long and short investors improve their stock market vision and understanding.
- Short selling data trail produces investing insights.
- Few listed companies experience a short selling attack.
- Number of shares issued, sold short and daily volume are important.
- Short interest indicates the strength of the short attack.
- Days to cover can inform investors of coming stock market drama.
- Check that the numbers used for analysis are comparable.
Other lessons related to: Making money selling short
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Comments and questions welcome
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Short story shorting stocks:
Short selling stock explained Lesson 1
Short selling improves markets Lesson 2
Short selling improves companies Lesson 3
9 Short seller facts align Lesson 4
Making money selling short Lesson 5
Shorting stocks has risks Lesson 6
Who’s selling your stock? Lesson 7
Short seller skill sophistication knowledge Lesson 8
Short seller cost control Lesson 9
Short selling has rules Lesson 10
Next lesson 6:
Shorting stocks has risks
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