I know Whitney Tilson from our Street.com days. He is a smart guy, and a very good Value manager.

But like many value guys, he can be early (on trading desks, they call that “wrong”). In his January letter to investors, he discusses some of his recent shorts that have not worked out (see PDF below). I love any money manager that does that — fearless, honest, self-reflective — these are the traits of a person who won’t make the same mistake twice. (Good for him)

When it comes to shorting, many people are in the dark. It is more challenging to be short, subject to squeezes; the return max out at 100% — versus unlimited upside for longs.

Over the years, I have put together some rules for shorting. These are pretty broad and general, but they have kept me out of trouble when

Basic Rules for Shorting Stocks

1. Shorting Momentum names is dangerous: Unless you are Superman, never step in front of a speeding locomotive

2. Valuation alone is insufficient reason to get short a stock — History teaches us that cheap stocks can get cheaper, dear stocks can get more expensive

3. ALWAYS work with a pre-determined loss – either a physical or mental stop loss — Never leave yourself open to infinite losses

4. Fundamentals tell you WHY to short something, not WHEN to short it. ALWAYS have some technical confirmation before shorting. Make a short selling wish list, then WAIT for technical confirmation. (We use Money Flow, Short Term Trend lines, Institutional Ownership, Analyst Ratings).

5. It is tough to be a contrarian: During Bull and Bear cycles, the Crowd IS the market.

You have to figure out two things:
a) When the crowd is wrong — Doug Kass calls it “Variant Perception”
b) When the crowd starts to get an inkling they are wrong

At the turns — not the major trends — is where contrarians clean up.

6. Look for Over-owned, Over-loved stocks: 95% Institutional ownership, All buys or Strong Buys (no sells), and 700% gains over the past few years are reasons to put names on your short selling wish list.  (That is how my partner Kevin Lane found and shorted Enron and Tyco back in the 1990s).

7. Beware the “Crowded Short“– they tend to become targets of the squeeze!

8. You can use Options to either juice your short returns, or pre-define your risk capital (options)

That is my short shorting list . . .

~~~~

Here is Tilson’s Letter to Clients
T2-Partners-Jan-2011

Category: Short Selling, Technical Analysis, Valuation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

18 Responses to “Rules for Shorting”

  1. call me ahab says:

    “Beware the “Crowded Short”

    so . . . not a player in Netflix ? (32% short ratio)

    or P.F. Changs? (33% short ratio)

  2. TripleB says:

    Adding to your point 4, I’m also a fan of never shorting a sideways market. Look for euphoria and then BE PATIENT, wait for the chart to stall out and turn south a bit.

  3. DrungoHazewood says:

    A lot of bears seem(ed) to be shorting really dangerous things like the deep cyclicals. Coming out of a crash, shorting CMI et al is an invitation to be carried out in a body bag. Yet people were drooling all over themselves to short financial thermonuclear devices. Then they were surprised when they were actually carried out in a body bag. The crash had already happened!

  4. eightnineEmous says:


    the return max out at 100%

    short 1 share at $10

    cover at $5

    using your original $10 and your $5 profit, short 3 shares @ $5 each for $15 cost

    cover at $2.00, which is a $3.00 profit on each share

    calculate profit:

    ($3.00 * 3) + ($5.00*1) = $14.00, which is a 140% profit

  5. AHodge says:

    tilson good
    but he did not mention open table OPEN that he publically said his best short late last year.
    i followed and lost, friend of mine made a little.
    but if he still in it in the $80s now he lost his f… ing shirt. how about a mention?
    You could think about shorting in recessions, or about to be recessions.
    Leuthhold and fleckenstein shut down their short funds in early 09, good move
    so mostly did i in April
    about a month and $300k too late but still OK time to flip long.
    right now not much for me
    i only short TAO which purports to be a Chinese real estate ETF but is only partly…
    and Ford early this week after getting hammered long into their earnings

  6. ES says:

    > Look for Over-owned, Over-loved stocks: 95% Institutional ownership, All buys or Strong Buys (no sells), and 700% gains over the past few years are reasons to put names on your short selling wish list

    CRM? But it keeps getting short squeezed too. With high institutional ownership there are just not that mny sellers and momo players keep piling in. At some point it will be a spectacular short. APKT too.

  7. VennData says:

    Bonds. Short bonds. …If you didn’t see that it was the time to do this a few months back and still don’t think it’s a good time to short bonds, you are not a short.

    …when regaling the uber-trading geniuses at the conclusion of 2011, they will ALL have been short the enormous, massively over-leveraged bond market.

    If shorting is so dangerous, then gunning shorts should be an excellent strategy. Why don’t you ever – EVER – hear people on CNBC who say, “Well what we tried to do here is force the shorts to cover..?”

    Shorting cannot, and will never, lead to infinite losses. Shorting losses are NOT, “not capped” (aka, they’re “capped.” ) unless your broker gives you infinite credit.

  8. MacroEconomist says:

    BR: You are far too generous.

    I allocate to HF’s for a living.

    This guy broke every rule in the book.

    Why should I pay fees to have somebody learn something so f*ckin obvious.

  9. contrabandista13 says:

    “….You must be a good bull trader to be a good bear trader and not the other way around…. ”

    That’s a quote from my old partner and mentor, a legendary trader on Wall Street during the 60s, 70s and early 80s….

    I responded, “…I’m in it for the money…..”

    He said, “…. You’re hired….”

    I’m so bearish it hurts, however, I’ve been jobbing this market from the long side trading in the mini dow. I don’t allow the bulls to intimidate me, I beat them at their own game by investing my money and not my emotions….

    For what ever it’s worth, I’m now looking for an aprox 5% correction to 11,400 basis dow, on the fast and furious side, down to 11,400… With a possible 10.4% down to 10,750 basis dow…. I would be very causious on the seconc leg… Big Ben will be fighting it hard…. And, that’s going to be very possitive for gold and silver…

    Tomorrow you can sell the last good news this market is going to have for a while, I’m short on the close and will add on tomorrow’s possitive NFP number….

    Best regards,

    Econolicious

  10. Captain Jack says:

    Just FYI I’m pretty sure Michael Steinhardt was the original ‘variant perception’ guy.

    Also, Stan Druckenmiller in New Market Wizards: “I never use valuation to time a market.”

  11. eightnineEmous

    Your math is off:

    ($3.00 * 3) + ($5.00*1) = $14.00, which is a 140% profit ​

    What you should have done:

    ($3.00 * 3) + ($5.00*3) = $6.00, which is a 60% profit ​
    Share prices can only go to zero — they can only lose 100%

  12. [...] The Rules for Shorting.  (TBP) [...]

  13. eightnineEmous says:


    ($3.00 * 3) + ($5.00*3) = $6.00

    ??? 9 + 15 = 24, not $6

    You are correct that you can’t make more than 100% using a single trade, but you can ride a stock down using multiple trades and make more than 100% total.

    Let’s keep the math simple and only have $10 out for each trade (recognizing that rolling the accumulated profits back into the next trade would actually increase your profits.)

    short 1 share @ 10.00; cover at $5;
    $10-$5 to cover = $5 profit

    short 2 shares @ 5 (for $10 total); cover both at $2.50;
    profit = ($10-(2*2.50) to cover) =$5

    short 4 shares @ $2.50 (for $10 total); cover at $1.25;
    profit=($10-(4*1.25))=$5

    By the time the price gets to 2 cents , using your $10 you’ll be able to short 500 shares; when it drops to 1 cent, you are still making $5 on the trade for a 50% profit.

    So the limit on a single trade is 100%, but by covering and shorting larger numbers of shares you can make > 100% on the ride to zero.

  14. eightnineEmous says:

    And when it drops from 1 cent you can short for 1000 shares and get a 100% profit on your $10.

    So adding up all of the profits from the earlier trades obviously puts you over 100% since you get 100% on the last trade alone.

  15. eightnineEmous says:

    for software geek in me and the pedants out there (and you know who you are):

    For the series to actually have 2 cents as a price point, I would have had to have started at $10.24 (power of 2 and all that)

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