Why sell short stock

Sell short strategies are often overlooked by long-only investors. But I think that they have to be included in any stock trading system used by traders. Also investors who invest in monthly to yearly periods could easily learn selling stocks short and also make money in price decline.

There are many examples to confirm it. Here you can see the chart of NFLX where multi-year uptrend was reversed and price dropped from 270 to 60USD , i.e. more then 75% during only a few months. It was a great sell short opportunity for traders but also for active investors.

The ideas for short sell of a company’s shares could be based on different assumptions. Investors or traders could use technical reasons or fundamental reasons. The best is to combine both ways.

Fundamental analysis for selling stocks short

Fundamental reasons for short sell trades are based mostly on overvaluation of the company based on economic reports company produces. High P/E ratio is a typical example of such valuation.

Global macro research brings another level of fundamental ideas based on global macroeconomic research for countries, regions or economic sectors. These ideas are often more tradable by using some basket of shares. Ideal asset class for short sell global macro strategies is exchange traded funds.

Catalysts to initiate selling stock short

Although fundamental research and analysis provides enough input to decide that the share price of a company is too high, it is not enough to sell short these shares on the market. The fundamentals are often overlooked by crowded investors thinking that “today’s situation is different.” They push the price up, and selling stock short against such strong uptrend is extremely risky.

A better approach is to wait for some catalyst that indicates change. The change could be in investor opinion, in share price behavior or in company actions. The more you can find, the better sell opportunity it can be.

One such catalyst could be change in economic expectations for the future provided by the company. Slowing revenue growth is a warning sign that profits could deteriorate.

One quite good warning sign that should alert you to think about selling stocks short is change of accountant of the company. If this happens more than once in a short period of time it is much more alarming. Similar changes in company management, especially in financial positions, signal the same. Time to start thinking about a short sell trade.

Another warning sign is that company officers openly talk about short sellers. It is in a situation when share price is already in decline. When the company blames price decline in its shares on short sellers it is a warning sign. A company’s best revenge against short sell activities is simply reporting good numbers. Decent companies do not focus discussion on short sell traders and investors.