Bloomberg reported that hedge fund managers increased their short positions while stocks moved higher last week. From the perspective of a contrarian, this is bullish for stocks because contrarians believe the majority of managers will be wrong at important turning points. Simple analysis like that is rarely useful or profitable and traders should dig deeper to understand more about how large short positions could impact the market.
Hedge fund managers are a group that includes some of the best investors in the world. Betting against them can be a costly mistake. Rather than signaling a potential decline, large short positions in hedge funds could indicate that price trends may not last for long. When they decide to buy and cover short positions, they will provide support to that stock which could stop declines shortly after they begin.
Large short positions might indicate there is little downside in heavily shorted stocks and traders should be buying dips in those stocks.
One of the stocks highlighted in Monday’s Market Brief as due for a bounce, Francesca’s Holdings (NASDAQ: FRAN), offers an example of how quick reversals can occur. More than 26% of the shares of FRAN have been sold short and each time the stock has become oversold in the past month, buyers have come into the market. FRAN gained more than 3.5% yesterday.
Traders with short positions are looking for a profit and may be quick to take that profit when a stock falls. Look for rapid reversals in this market, especially in stocks with large short positions.