Avoid the Next Short Seller Attack
By Patrick Cox
September 9, 2010
For the most part, it’s just accepted as a fact of life that emerging small caps with technologies that are not well understood by the public will be targeted by attacks from short sellers. But there’s more to the battle between short sellers and investors than meets the eye — here’s a look at how you can avoid falling victim to short attacks…
It’s difficult, of course, to know for sure when short attacks are under way. Short sellers can, in fact, provide a service to investors. If you want to know that you can sell your stock for a predetermined price at some point in the future, regardless of market fluctuations, short sellers provide a kind of insurance. There’s nothing wrong with short sellers who engage in that sort of insurance policy speculation.
Shorting a stock to intentionally drive its price down, however, is illegal. As a result, people aren’t going to publicly admit that they are trying to manipulate prices. Furthermore, it’s extremely difficult to prove that an individual or individuals has made a series of large shorts to panic stockholders. The SEC simply does not have the resources or focus to detect and punish every such short attack. There have been regulatory limits placed on short sellers in the past, such as the uptick rule, but they are not currently in place.
Nevertheless, it is clear that, on occasion, a company’s stock will be driven downward by short sellers. Even though there is absolutely no news that would warrant a sell-off, you will suddenly see a stock’s price dive. Because short sellers make money by buying shares of stock at depressed prices, there is a transfer of wealth from investors who panic sell to short traders.
Personally, I think short sellers who arrange these attacks are despicable. I may not be as adamant as Jim Cramer, who frequently calls for stern legal and regulatory measures, but I agree with him in principle. Short attacks demoralize small investors as well as the management of the companies they target. Systemically, they have a depressing effect on the entire market. Of course, their effects are even more serious on the targeted companies.
When shorters drive a stock price down on an emerging tech company, remaining stockholders inevitably turn to the company’s management for an explanation. Executives and scientists who should be moving their technology forward are forced to deal with investor angst. If a short attack occurs in the middle of a financing round, it can raise the cost of capital. This can hurt the company’s finances and slow its progress.
As you know, some of my Breakthrough Technology Alert readers have reported that their brokerage firms have contacted them, offering a small fee for use of their stock as instruments in a short contract. If you think about this, it is truly amazing. First of all, the brokerage firms appear to be asking investors to help them exert downward pressure on their portfolios. This may not be true, of course, but if your neighbor is a convicted arsonist and he drops by to borrow some gasoline and matches, think twice.
Moreover, the very act of announcing that a specific stock is likely to be shorted raises the possibility of concerted short selling. This cannot be good for stock prices. After all, if you believe, based on such an offer, that your stock is likely to go down, wouldn’t you short it yourself or just sell it before the attack?
It really seems to me that such offers to “rent” stocks for short attacks could actually be used as part of short attack strategy. If a large number of investors in a company are offered a fee for the use of their stock in short sales, the likely effect is downward pressure on the stock price. It’s hard for me to see this behavior on the part of brokerages as responsible.
There is an upside to short attacks, of course. If the targeted company’s fundamentals are solid, stock prices will eventually return to a higher level. After short sellers have looted current investors, new buyers are then able to pick up equities far below their real value.
On occasion, however, short sellers overplay their hand. Just as investors can be caught up in trends, short sellers can fall prey to herd behavior. When this happens, too many contracts for short sales are made. When short sellers are forced to go to the market to get the stocks needed to cover their contracts, they push the value of the stock up themselves. This is better known as a short squeeze…
As you probably know by now, I don’t follow fluctuations. They make me crazy, and in the long run, they are largely irrelevant. Moreover, I don’t think it is possible to concentrate on scientific and market fundamentals while simultaneously paying attention to irrational market swings. If you’re a long-term transformational investor, you’re probably going to enjoy a higher level of sanity if you practice a policy of “buy and ignore.”
Follow the company’s public statements, but not the ticker.
For transformational profits,
Patrick Cox
