7/16/2007

Mark Boucher on Short Selling

Mark Boucher in his book The Hedge Fund Edge primarily talks about two short selling strategies:
  • Downfuel based shorting (in most market environment)
  • Former leaders breaking down
The objective of using these strategies along with the long strategy can help achieve smoother returns, allows one to hedge part of long portfolio, and helps make profit in bear markets. Mark Boucher gives detail rules for both strategies in his book. Understanding the two strategies can help one design similar short selling strategies, or replicate those strategies.

Downfuel Based Shorting
The concept behind this method is to find stocks which have fundamental factors favoring likelihood of accelerated down move.
I am just listing broad outlines of those criteria. In his book it is detailed with exact values.
  • Earnings based criteria like loss, or earnings decline, at least 2 quarters of down earnings.
  • P/S>10
  • P/E> S&P P/E
  • Declining sales
  • IBD EPS rank <50
  • Low ratings by Value Line, Zachs, or Lowry's rating services
  • Yield <5%
  • Debt levels
  • Should have fund ownership >30%
  • Low relative strength
Boucher recommends selling short such stocks when they break down from certain technical patterns on 4 weeks time frame.
The exit is based on rigid criteria which look for either earnings turnaround or relative strength turnaround.

Former leaders breaking down

The concept behind this shorting method is to look for topping patterns on 6 month time frame on former leaders or stocks which have gone up a lot in bull market.
  • 6+ topping patterns (Double Tops, Triple Tops, and Head-and-Shoulders Tops)
  • P/S > 3 (ideally >10)
  • P/E >the last year's earnings growth
  • P/E> the next year's projected earnings growth
  • Slowing earning growth
According to Boucher big money is made shorting major chart breakdowns in stocks where expectations have been out of line with reality, that are starting to disappoint investors that held those out-of-line expectations. He advises using this strategy when you are in beginning of a confirmed bear market.

2 comments:

christmasfern said...

An interesting development to note is the relative weakness that has developed in the small caps, and especially in Russell 2k value (RUJ). This index had always been a leader until recently. Also REITS continue to be very weak, and banks, and homebuilders. I dont short or buy the indexes but if i was going to short an index it would be the Russell 2k value. (SJH is the levereged short ETF)

Pradeep Bonde said...

Good call.