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How to find high probability shorts

Posted on 2/28/2007
If you want to find shorts with 5%-20 opportunities, there are many ways to do it. Those are normal pullbacks in most stocks. But if you want to find long duration plus more profitable 30% plus kind of shorts, the task is slightly more complicated.

The reasons are obvious. Unless you are genetically predisposed to bearish strategies a simple study of worldwide market tells you that there is a steady upward drift in the markets. That is why passive investment and Index based long strategies work so well. So structurally one must accept lower profit on short ideas. The other problem is you will find very few smooth waterfall moves down. While you will find many smooth multi year up moves on stocks.

So given all those constrains in my scheme of things short is a low priority trading opportunity. Unless there are no compelling longs I don't look at shorts. However I have spent significant time and effort developing some profitable short strategies. Because under certain circumstances they offer good opportunities.

The central concept behind most of my short ideas is based on the post I made some time ago - Earnings expectations and Cinderella Strategy. Essentially you must find a earning torpedo. If you find it on high growth stocks, which has been bid up a lot and is the darling of big funds, you get one smooth ride short. Such things are rare but highly profitable. Catalyst is extremely critical on short side, otherwise usual corrections are quickly bought. A mere miss on earnings may not be best short strategy. What works is if you have a sequence of earnings like say 30, 34, 45, 50, 44, 69, 40, 34. 69 , and then 7 or -20, then there is virtual scramble to get out. Because before the torpedo the stock was favorite of all growth funds

Now how does one find such stocks. One way is to follow the earnings. But there are other problems associated with shorting and that is availability. So after a considerable research and practical experience as a choice I have decided not to look at such stocks on below a certain float thresh hold. Stocks with low floats can make good shorts, but I seldom get a supply of them. So most of the time by choice I concentrate my shorting efforts on 100 million plus float stock.

Now regular readers of this blog know, I am always looking for some short cut to find such stocks. So I have found some pre existing lists which offer you good short candidates. So here are some concepts which will get you high probability shorts:
  1. IBD Mutual Fund list: On Page A9 everyday IBD publishes two lists. Largest Positions of funds in Big Cap Index and Largest positions of funds in Value Index. This list changes very slowly. Essentially a fuck up on any one of the stock in the Growth Fund list is great short. Similarly any new addition/subtraction is worth paying attention to. There are only 20 stocks in the list daily. ( This list is also useful for long ideas)
  2. Trouble after Double: This is all those stocks which have 100% or more growth in last 2 years and float above 100 million and during the move crossed price of 40. On this list I look for 4% down moves for entry. ( All stocks which during last 540 days period doubled from their 260 days low and have a float of 100 million and were priced 40 plus. Don't ask me how to do it in TC2000. You can not do it in that programme.)
  3. Episodic Pivots: Here you are again primarily looking for earnings miss or regulatory trouble.
  4. Now besides this earlier I have used another ready made list which uses a slightly more advanced concept of torpedo strategy and offers some very good opportunities- Earnings Torpedo Warning list. This list is maintained by Ross School of Business @ the University of Michigan.

As usual do your own research before trying any of these. The key is to understand the basic concept.

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walter said...

looking forward to going thru this...

walter said...

ADBL very nice breakout above long term downtrend line...

Pradeep Bonde said...

ADBL earnings breakout

Unknown said...

I know this is IBD. Looking forward to see how to get benefit from this newspaper.-Thanks-mjps

Lao Tzu said...

I don't believe you can find short opportunities numerically. I would just watch newspaper reports alongside earnings.

When your gut tells you something's being over-hyped, look at the earnings reports and see if the story matches.

Currently I'm short of gold for this reason.

* Nice that you point out that longs are gradual & reliable and shorts steep and sudden.