This is Why I Don’t Short Anything Anymore

The moment of maximum pain.

Goldman Sachs called for the end of the epic short-covering rally that had whipped crude oil, oil & gas drillers, and the broader markets into froth over the past three weeks. As if on cue, the rally started to unwind today. But it was scheduled for demise from get-go. When oil fundamentals are this terrible, they eventually rule.

And here is what that rally did: It inflicted maximum pain and destruction on the short sellers that had piled into the trade.

Last week was the climax of a run that had started on February 12. Crushed energy companies, especially those lurching toward bankruptcy – the most shorted companies around – had a blistering week as short sellers had to buy back shares to cover their positions, or else get their heads handed to them.

When a stock you’re shorting rallies 100%, you face total wipe-out. But it doesn’t stop there. Losses are theoretically unlimited. If the stock rallies 200% or 300%, you lose multiple times the amount of the original bet. If your bet was big enough, you might lose everything you own. Shorting is not for those who easily vomit.

And no one feels sorry for shorts when they get massacred. “Serves them right,” is the normal response. “How dare they bet against me!”

Skyrocketing 200% or more in three weeks is precisely what some of these near-bankrupt most-shorted stocks did. But the short-covering rally extended far beyond a few energy stocks. Since the February 11th low, the best-performing stocks in the Russell 1000 are those with the highest short interest. Short interest is the number of shares investors have borrowed and sold short.

In terms of short interest, the top quintile – the 20% most shorted stocks – in the Russell 1000 jumped 27.1% in three weeks. The next quintile rose 16.4%, and so on. The dynamics of the short-covering rally supports the theory that that’s all it was.

One of the most shorted stocks going into the rally was Chesapeake Energy. By mid-February, short interest was 235 million shares, about 40% of the public float! Any squiggle in the market triggers fear among short sellers of losing their house and first born, and they scramble to cover their short positions by chasing the now soaring shares skyward to try to buy them at ever more elusive prices.

It’s a terrible feeling. It’s the moment of maximum pain. But their concerted efforts to buy these shares at whatever price reverse a crash. Shorting is a form of plunge protection!

Chesapeake ended February 12 at $1.59 a share. On March 7, shares closed at $5.23 a share. They’d rallied 228% in three weeks. For shorts, an excruciatingly painful event. And the very fear of getting mauled like this contributed to this epic short-covering. But today, the short squeeze came unglued, and shares re-plunged 18% to $4.27.

Shorts betting that the shares will go to zero in a debt restructuring may ultimately be proven right, but if timing is off by only a few days, they may, so to speak, lose their house and first-born in the process.

The bitter irony? The short-covering rally in the energy sector was driven by the short-covering rally in crude oil, but Chesapeake gets 72% of its production from natural gas, 11% from natural gas liquids, and only 17% from oil.

Alas, US natural gas hasn’t participated in the rally. It’s still trading at totally collapsed prices, after a death spiral that started in 2009. It has already pushed smaller natural gas drillers into bankruptcy. Folks are betting that Chesapeake, the second largest natural gas driller in the US behind Exxon, is the big whale, and that the natural gas bust will only end after that big whale washes up on the beach.

That equations hasn’t changed. The price of oil is nearly irrelevant to Chesapeake. Yet, its shares rallied more than those of oil drillers.

The logic of the shorts can be perfect, but if timing is off by just a few days and a temporary miracle happens or the CEO utters some ludicrous piece of hype, then shorts get their heads handed to them.

And that’s why I no longer short anything, no matter how obvious the bet, not even the “short of a lifetime.” I leave that up to braver souls. Because it’s just me out there, against the forces that will hype the shares with all their might, supported without questioning by much of the financial media, and they all try to run shorts into the ground as if that were their patriotic duty.

But a megaphone that is big enough to trigger the crash of a stock takes some risks out of shorting. Short sellers like Citron Research or Muddy Waters poke around the company and find some dirt. After they quietly take a short position, they publish their research via their big megaphone, and it shows up everywhere.

If the stock, like Valeant, is a hedge-fund darling, the reaction is brutal. Hedge funds, aware of the first-mover advantage, try to get out the door first, thus guaranteeing a selling spree that spooks other investors. And it spreads from there. After shares have plunged 75%, we find out that Citron has exited its short position, laughing all the way to the bank.

But short sellers that cannot cause a stock to crash and simply follow their own logic, figuring perhaps correctly that Chesapeake is heading toward zero, can become cannon fodder within a few days. And that’s how it was designed to be.

Just how overvalued are stocks, particularly small-caps? According to Wall Street, even the question is wrong! Stocks are always a buy. The future looks bright. And even if it doesn’t, analysts come up with “adjusted” earnings to blind even innocent bystanders. But now, actual earnings are tanking and P/E ratios are blowing out. Read…  OK, I Get it, this Stock Market Is Going to Be a Mess

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  37 comments for “This is Why I Don’t Short Anything Anymore

  1. GatoHead says:

    I still go short more often than long these days, fully aware of the inherent risks and cognizant that the game is rigged against me (and shorts in general).

    It’s essential to maintain tight (or relatively tight) stops and not hold positions overnight (esp stocks and options).

    More often than not, shorting is harder and less fruitful than going long (esp when the game is rigged), but I sure as heck don’t wanna be a buyer at these levels.

    • DanR says:

      I found with the stock market that including shorting in methods made such methods far less reliable. I think the higher volatility during downtrending markets introduces too much uncertainty for slower more out of the loop market players like me.

  2. Bigfoot says:

    Kinda hard to beat the bots these days. I traded commodities & indicies futures on a regular basis from 95-2001. Studied most of the traders highlighted in Jack Schwagers’ Market Wizards books & probably every system that was out there at the time. Took awhile to finally flesh out my own style/system that was profitable, but I made some good $ the last couple years. I only stopped because I had a small biz going & one can only survive on 4 hrs of sleep a night for so long. I spent hours late into the night studying most all the markets through that period.

    You could see the manipulation in the various markets back then but in the 15-20 years that has passed, it’s just become over the top. CB’s seem to have their hand in everything now, HFT’s, dark pools, yikes!. I relied on a mix of technical & fundamental analysis & thought I would get back into trading when I got to retirement age. I’m getting close to that point now, but the ‘markets’ if you can even call them that anymore, have devolved into such a cesspool that my main focus is capital preservation. I’ve nothing left in the system except for some captive Roth funds. I’d rather buy some land & grow a garlic crop than try to bob & weave through the minefields we’re presented with today.

    If I had been actively trading & shorted most any market/stock that looked like a solid bet the last 6-7 years, I wouldn’t have any capital to worry about preserving. I just buy TVIX (with captive funds) now & wait for a nice spike. Plenty of time to wait it out & the odds of a huge spike not too far down the road seem inevitable. This isn’t for the squeamish, I’ve been down a little over 20% so far in just the last 2 weeks, but I have a long time frame & lots of patience.

    You certainly nailed it reference to the timing being so crucial on those shorts.

    • alex says:

      I’m doing the same thing, big foot!

      I’m doing this with Tvix a while. I wonder which etf thats reverse of VIX so I can buy it when stocks start to rally? 2x or more leverage if possible

      • David in Texas says:

        XIV or SVXY are inverses of the VIX.

      • Bigfoot says:

        Alex, you can short TVIX as well. Interesting to finally run into or hear of someone taking this trade.

        I made right at 300% last year on just 2 TVIX trades (longs). If you are scalping, there were numerous opportunities for 20%-40% trades as well. So far, when it spikes, you generally only have 1-2 days to close out your trade as it has come right back down in rapid fashion.

        I put my last trade on at 8.10 a few weeks ago which I mentioned on this site in another post. My rationale behind the trade is as follows. TVIX is near enough to the bottom of the range that the likelihood of a small to possibly huge spike due to the markets heading south seems almost a given, particularly since I don’t have to focus on a narrow time frame, which is KEY. There are so many financial negatives stacked up out there! Monetaryl time bombs with the fuses lit all over the world. If S&P drops 5%, a spike of 100% in TVIX should easily occur. If we get a blowout, you might get a 5 or 10 bagger.

        I am not & will not short it as I’m not day trading. The only short I will consider with TVIX is if we get a blowout in the markets & it went to the moon while I was long. I’d take profits & reverse positions as the market will eventually stabilize & TVIX would drop like a stone.

        Psychology plays such a crucial role in trading & I believe it is just as if not maybe more important than your methodology. I’m in an enviable psychological state. I don’t give a damn. My funds are captive without paying the tax man for extraction. I’d rather lose it ALL! I don’t put these trades on with any fear. I don’t even scale into the trade like I have customarily done in the past. I pick a spot & put up all the chips. It worked great last year, we’ll see how we do this year. I will post results, time is on my side, I think I’ll go spin some Pink Floyd Time & put on the headphones :)

        Best wishes

    • Paulo says:

      I chuckled at Bigfoots: “& thought I would get back into trading when I got to retirement age. I’m getting close to that point now, but the ‘markets’ if you can even call them that anymore, have devolved into such a cesspool that my main focus is capital preservation.”

      I have a very good friend who is almost retired and studies his mining company stocks every night/weekend and buys/sells accordingly. He does, or has done fine over the years, but I always wonder about his actions? First of all, everything is rigged and HFT changes everything. How can you believe you have smart picks and the smarts to pick in a phony and manipulated market? Furthermore, is that how you want to spend your winding down days on earth, staring at a computer screen and trying to make more money?

      Oh well, every few weeks I check up on our balances in terms and GICs. This summer I have a term coming up and will dole it out to myself as per tax levels dictate. Last night I returned home with a new batch of layer chicks and pullets. I have some trees to buck up today and the generator to gas and ready before our next big storm. Supposed to blow 55kts and the power will surely go out.

      There is more to life than making more money. Ferris Bueller says it best: “Life moves pretty fast. If you don’t stop and look around once in a while, you could miss it. ”

      Good luck, Bigfoot. Now, if they don’t get rid of ‘cash’ and they forget about ZIRP, we’ll probably be fine. Bastards.

  3. Cooooooooon says:

    The word “harvested” comes to mind..

  4. Mark says:

    Amazing read. Well, Mr. Tilson has just hit LL again today.

  5. Jonas says:

    I buy puts in Bubble stocks (tsla now, formerly biotech, etc) as portfolio insurance and as outright trades. Yes there is a premium but i sleep soundly at night! And it’s not as if shorting shares was free either.

    One exception are pair trades (short shares inn one security, long another) for relative performance ( market neutral) trades. But in Times like these even those are too risky.

  6. Chicken says:

    Shorting looks pretty safe to me if you can manage position size. As long as you have the cash you’ll never have to cover, no? Choose wisely!

  7. david says:

    Got back in yesterday and for my trading portion I go on sell the rip, as TPTB will push it back up…..for awhile. Been short sears for a year and have no plans to close it. I use inverse funds mostly as highly unlikely it doubles, tech and energy I stay away from.

  8. Oliver says:

    Is the problem with shorting itself or with the size of the bet ?

    If a short is threatening to take your house and your first born chances are your bet is simply too high. You just can´t ride out the volatility to see your hunch, intuition or hypothesis come to fruition.

    Put differently, would you bet your house and first born on a single hot stock in a bull market ?

    Probably not.

    • Bigfoot says:

      Probably both ?

      The ‘show’ is so controlled/rigged it’s difficult to use technical analysis. Trying to reconcile anything on a fundamental basis leaves your mind twisted in a knot.

      If you are risking more than 2% on a given trade you are either trading under capitalized ( why most lose ) or have no clue about proper risk management.

      If I was focused on speculating these days I think I’d be primarily using out of the money calls/puts with a long event horizon. If you are risking your ‘house’ on a single trade, ya might want to shop for a tent. Regarding the first born, they’ve already been commoditized & securitized by the ‘ overlords’.

    • Jungle Jim says:

      Well no, you or I wouldn’t, but when you hang around short sellers, all too often you’ll hear the words “back up the truck”. Those are the people who think they have an edge, and go too far. But I agree with Wolf, these days shorting is just too dangerous

  9. Mark in Denver says:

    That big “wale” isn’t going to wash up on the beach, but a “whale” might.

    • Wolf Richter says:

      Oops. Thanks! It’s fixed.

      • alexaisback says:

        Wolf you might want to look at this too.

        Peabody Energy

        2 Billion in bonds trading at .03 on the dollar

        and the stock is up 47 % in last 2 weeks

        like Cheasepeake 40 % float was short
        and this has a relatively low low float


        • Wolf Richter says:

          Especially since Peabody appears to be on the verge of bankruptcy, which is reflected in the price of the bonds you mentioned.

          But then, to show how rational some “investors” are: after companies go bankrupt and issue new shares to their creditors, their old shares no longer represent anything, yet these now totally useless shares still trade over the counter, sometimes for quite a while, jumping up and down and having a great time.

  10. Álvaro says:

    May I suggest the name of your next post?: “How long before the shit hits the fan?”

  11. Lee says:

    As I posted on that other thread, here is the ‘short of a lifetime’ for those that think Australian real estate is a huge bubble:

    short the Australian banks.

  12. Agnes says:

    What about going long? Google’s deepmind program Alphago just beat one of the top ten (human)players in the world. An Hour ago….first of 5 games…I bet goog goes up this week.

  13. Jonathan says:

    Brent hits $40 at a time when China imports has been declining for like 15 months straight and just dropped by a massive 13.8%, while oil storage is ever closer to exploding. You can’t win in this market as far as sanity is concerned.

  14. d says:

    I trade indexes, commodity’s, and currency’s.

    And regularly short them, as I am Agnostic to direction.

    This Approach this would not work on individual stock’s.

    Those who short individual stocks need very good information, and analysis in most cases.

    For me picking individual US stocks is akin to stepping into a very rigged Casino.

    Read the Auckland segment, then think Auckland, as a suburb of Sydney.

    Before you short those Aussie bank’s, AKA the widow-maker..

    • Lee says:

      The market downunder is rigged just as much, if not more, than other markets around the world.

      Especially when it comes to mining and oil shares or ‘director lifestyle companies’…………….

      I would NEVER short the banks here.

      Not only would you have to pony up for any increase in the value of the shares and dividends paid out, but as a result of the current tax system on dividends, you’d have to pay the imputation credits as well……………..

      ANZ currently yields 7%………………..which is fully ‘franked’.

      • d says:

        “The market downunder is rigged just as much, if not more, than other markets around the world.”

        I have written more than once both ANZAC Markets are a crony closed shop.

        I only trade the currency’s. I Only do then main indexes S&P mainly. As i have good indicators for it.

  15. wholy1 says:

    In so long as the “Fraud Preserve” and other central banks remain relevant in additional debt-creation by fiat via “private, off-shore” “dark liquidity pools” such as Citadel, the “rogues” (outsiders) will continue to “lose their shorts” when the “insider PTB’s” (Psychopaths That Bugger) find it sufficiently both financially and politically advantageous. Until central bank fiat debt creation goes the way of Zimbabwe – short at your own risk.

  16. SRV says:

    The short squeeze was engineered by the WS banks to allow their debtors to raise the cash (in public offerings the banks underwrite with full knowledge of the financial hole they are in… fraud) to pay off the loans they have with the banks.

    WS wins and the public is left holding the bag… bit of an echo in here today!

  17. Markar says:

    Lots of gamblers here today. For my money, I’d rather bet red or black on the roulette wheel. At least I get free drinks.
    The house always wins in the end.

  18. Merlin says:

    not from Wales, but the banking/brokerage whales make me wail (and curse, cry and gnash me teeth) in the dark.

    Viva le Paulo,

  19. RDE says:

    re short squeezes

    There is a reason why God invented options.

  20. walter map says:

    Sometimes I just don’t what to believe.

    Markets Are Stretched, So I’m ‘All-In Short’

    I’m so conflicted.

  21. Oleaginous Outrager says:

    So Cheesypete stock, despite its latest “plunge”, is still valued at 2.5+ times its low of the previous month on, what, exactly? “Momentum”?

    Someone said something about fiction peddling recently, can’t recall exactly what that was all about.

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