How to Profit from Shorting Stocks

Have you ever wanted to know what companies the professional firms are betting against?

Personally, I love information like that.

It gives you that little edge when you invest. Or at least gives you pause for further thought.

Right now for instance I can tell you that Syrah Resources [ASX:SYR] is the top shorted stock on the Australian Securities Exchange.

This means that a lot of, probably professional, investors are shorting stocks. A process by which they can make money if the share price decreases.

Right now, 20% of Syrah’s stock is sold short. That’s quite a lot. That’s 55 million shares in total.

Do you have shares in Syrah?

If so, did you know that?

It’s interesting information, don’t you think?

Although I’ve got access to expensive Bloomberg data, there is a public source of this information. A site called shortman.com.au.

It’s a great little site for the amateur sleuth to start digging up an opportunity.

Along with ‘insiders buying’ data, this is my favourite bit of extra information when I look at an investment.

It’s actually the last thing I look at.

That’s because I don’t want it to influence the earlier stages of my research process.

And also because this information becomes key in timing an entry point into a promising stock.

Let me explain…

Two ways to profit from shorting stocks

There are two ways you can use the ‘short numbers’.

First, it can act as a warning bell. A hint to re-check your numbers.

You might have got carried away with your research and started getting excited on a stock’s prospects. Only to find it is heavily shorted.

If it is falling and is heavily shorted this can be a very bad sign. Especially if the market or sector is in a depressive mood. Maybe you can afford to wait.

More experienced investors can use this information in a riskier, but potentially more rewarding, way.

A short squeeze is a situation where the price moves unexpectedly higher. Remember, this is bad for the short sellers.

If there are a lot of short sellers, like in the Syrah example above, there will be a high level of buyers trying to buy back in to close their trade.

Taking the Syrah example further, this is a stock that trades around 2 million shares a day. With 55 million shares sold short, it would take 27 days for all the short sellers to close their positions.

This is a great risk for short sellers in a crowded trade.

But a great opportunity to profit from their weakness.

As you probably know, Syrah is a big graphite project.

Imagine it announced out of the blue a massive order from a company desperate for their high-quality graphite. This is a fictitious but plausible scenario for Syrah.

The share price would rocket as the short sellers tried to exit. Investors keen to buy in on this big news would also push the share price higher.

The shorts would panic. Much in the same way buyers panic when markets fall dramatically.

This event is known as a short squeeze.

And if you are on the right side of such moves, it can be a good way to make a quick buck. But like I said, it’s risky. Do you know more than the professional shorters? It’s highly unlikely…

Economics schmeconomics, it’s all market dynamics

This heading is a line from the famous Nassim Taleb book, Fooled by Randomness.

It underlines the take away from all this. Which is a simple but important reality.

Stock investing is, in part, a process of reading market dynamics. What the buyers and sellers are doing. Especially those with informational advantages.

It’s all about working out the mood of the market or a stock.

Fundamental research is of course important. But many people forget that if you buy a great stock at $10, it’ twice as good if you can get it at $5. And that’s what reading market dynamics can help you with.

You don’t need to agree with the market.

But you do have to acknowledge its awesome strength and power to move prices.

The best investors learn to think independently, but invest with market dynamics in mind.

Good investing,

Ryan Dinse,
Editor, Money Morning

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Ryan Dinse is an Editor at Money Morning.

He has worked in finance and investing for the past two decades as a financial planner, senior credit analyst, equity trader and fintech entrepreneur.

With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle.

Different market conditions provide different opportunities. Ryan combines fundamental, technical and economic analysis with the goal of making sure you are in the right investments at the right time.

Ryan's premium publications include:


Money Morning Australia