Here’s Why I Avoid Shorting These 3 Types Of Companies

  • May 5, 2004
  • Rob Hanna


Today was another move up on light volume. This
is the third lower-volume rise in a row for the Nasdaq.  As everyone knows, I
don’t believe this is positive action for the market. To me it looks like a
pullback that is setting up to make another dive lower. I’ve received some
questions about shorting recently. For you bulls, the only way I know of to
ensure the market keeps rising is for me to keep writing about shorting, so here
goes.

 

One question I received
recently with regards to shorting stocks was:
“Are there any industry groups or
types of companies you would avoid shorting?”

 

There are 3 groups of stocks
that I would be especially wary of when considering short candidates:



  1.      Companies
    with low average daily volume.     Not only does low volume make it
    more difficult to get the short off in the first place, but if the trade
    starts to go against you, it could run up that much faster. Being short when a
    squeeze occurs isn’t any fun, but it’s even worse with a low-volume stock that
    refuses to give you a good fill.

     


  2. Companies that pay high dividends.     An example here would be many of
    the REITs. I wouldn’t necessarily avoid these altogether, but make sure that
    you are aware of when the next dividend is scheduled for. If you are going to
    have to pay a huge dividend in a few days, then that payment should be
    factored into your risk/reward analysis, since it will effectively be raising
    your cost per share by the amount of the dividend.

     


  3. Biotechs     — From a fundamental standpoint, many biotechs commonly
    look pretty bad. This is because most of them don’t have earnings. The problem
    with shorting individual stocks in this group is the incredible volatility
    that can be associated with good news. A biotech that is looking to find the
    cure for cancer may be losing money consistently, but what happens if they
    actually find the cure? To see just how volatile these companies can be, just
    take a peek at a recent chart of Osi Pharmaceuticals
    (
    OSIP |
    Quote |
    Chart |
    News |
    PowerRating)    .  I would
    hate to have been short that company on the morning of April 26. You’re never
    going to see Wal-Mart
    (
    WMT |
    Quote |
    Chart |
    News |
    PowerRating)     or Coca-Cola
    (
    KO |
    Quote |
    Chart |
    News |
    PowerRating)     do that to you overnight.
    It doesn’t matter how much they sell. If you really feel biotechs are due for
    a fall, then you may want to consider trading
    (
    IBB |
    Quote |
    Chart |
    News |
    PowerRating)     instead, as that will
    be less volatile than most individual issues.

These groups of stocks all skew
the risk/reward ratio of a trade in a negative manner. Therefore, I would prefer
to look to more traditional trading stocks when looking for short opportunities 
If you elect to short a stock that fits into one of these categories, then make
sure you factor the extra risk into your risk/rewards analysis so that you don’t
overextend yourself.

 

Best of luck with your trading,

 

Rob Hanna


robhanna@rcn.com