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Short Screen offers tools and ideas for short sellers, including a screener that pulls up companies predicted to go bankrupt by their Altman Z-scores. Here is a link to a third party review of the site, Screening Stocks for Short Selling. Here is a link to a post dealing with some common questions about short selling and risk.

More on short selling and risk

In the comment thread below John Chow's follow up post on Short Screen, a commenter wrote,

If you go long the maximum you can lose is 100% of what you invested. (As I did with my smart investment in Enron!)

If you go short, but the shares rise in value, you then have to purchase them at this higher amount. How much is that higher amount? It is limitless. Thus you are exposed to a massive risk that is unknown at purchase.

Imagine you had decided to short Volkswagen before the massive swing in its share price saw its market capitalization hit $364 billion, making it the most expensive company in the world. Many experienced hedge fund managers were on the wrong side of this trade.

Shares prices do move sharply, particularly those thinly traded and small caps. If you are going short, then you could well be in for a nasty shock.

I recommend The Intelligent Investor by Benjamin Graham (first published in 1949).

In response, I wrote,

Questions about short selling and risk came up in the comment thread following Michael Kwan’s original review of Short Screen. I summarized those questions and addressed them on my blog, if you would like to take a look, “Short selling and risk”.

The Intelligent Investor by Benjamin Graham is an excellent book. I have read it and would recommend it as well. Regarding Graham, you may be interested to know that one his first teaching assistants and proteges, Irving Kahn, is, I believe¹, still an active investor at over 100 years of age. Kahn is no stranger to short selling. In fact, an article in Smart Money several years ago noted that one of Kahn’s first big investing successes was with a short:

Along the way, Kahn got to know many of Graham’s famous disciples, including Warren Buffett. A gutsy Kahn wasn’t swept up in what he calls the “crazy market” of the late 1920s. In fact, his first trade in the summer of 1929 actually was a short sale of Magma Copper that turned out to be a winner in a few months.

¹Kahn is still listed under the investment personnel section on the Kahn Brothers website, so I assume he is still alive and investing.

John Chow on Short Screen and Tim Sykes

John Chow on Short Screen and Tim Sykes, as resources for investors looking to short stocks: "Going Long on Going Short".

Ill-equipped to act, with insufficient tact

This didn't last long. On the advice of one of my developers I deviated from the personalized tweeting and sent the same reply to 20 or so folks on Twitter yesterday. I searched for people tweeting about short selling and then suggested they might want to check out shortscreen for other short ideas. In fairness to my developer, he didn't suggest to do that, exactly: he suggested to tweet a handful of folks at once. In any case, my Twitter account has been suspended, which frankly surprised me.

Judging from 100% of the tweets I received from 30 individuals over my few days-long Twitter career, my tweets were better targeted and more relevant than pretty much any of them. For example, unlike the fellow who managed to send me -- someone hasn't golfed in maybe four years and has a set of Costco clubs gathering dust somewhere -- 20 links to golf tips in two days, I only contacted actual short sellers about a site geared to short selling. That's not to suggest that all of the tweets I received in the last few days were commercial in nature: some were just inane bits of trivia, e.g., the one from a woman in the Southwest who mentioned that she had moved that day and asked if anyone else liked moving.

I appealed for clemency to the powers that tweet, noting that after reading the TOS I understood my mistake. The form for contacting Twitter about stuff like this includes a field asking "how do you feel"¹. I entered "chastened". But I am of two minds about this. On the one hand, the ratio of visits to Shortscreen from Twitter to my tweets was pretty high -- about 50%. On the other hand, the whole Twitter enterprise seems like a pointless time suck. So I leave it to the folks at Twitter to decide if my tweeting days are over. If they are, so be it.


¹This question reminded me a little of that test the reincarnated Spock takes at his parents' house on Vulcan in Star Trek IV. He gets a series of questions, one of which goes like this, if memory serves, "Adjust the sine wave of the magnetic envelope so that anti-gravitons can enter and anti-protons cannot". And then he is stumped by the last question, "How do you feel?".

Short selling and risk

At the suggestion of my developers, I requested a review of Shortscreen by John Chow's site. You have to pay to have your site reviewed by John Chow, but he and his team are free to write whatever they want about it: they have complete editorial control. The review is up now; you can read it here: Screening Stocks for Short Selling.

A couple of the commenters raised reasonable questions about the risks of shorting. I addressed those questions in the comment thread there, but it's worth recapping here too.

Question/comment: Additionally, short selling as a whole is risky because you can lose an unlimited amount of money because a stock can go up an unlimited amount theoretically.

Answer: There is a way to limit your downside, if you want to bet against stocks: you can buy puts on them instead of shorting them. As with shorting, you’ll profit if the stock drops, but in the case of buying puts, your maximum loss is limited to what you paid for the put. You can use Shortscreen to screen for candidates to buy puts on as well as to short.

I personally don’t limit myself to buying puts, because I believe there are often better short selling candidates among stocks that aren’t big enough to have options traded on them. There is of course a risk that I will lose money on some trades, but by limiting myself to shorting stocks that a highly accurate model predicts are headed for bankruptcy, I believe the odds are on my side.

Question/comment: Selling stocks short is a good way to also LOSE A LOT of money.

Answer: Although there are risks involved in short selling, it’s important to note, as a previous commenter alluded to above, that, for knowledgeable investors, adding short selling (or buying puts) can reduce the overall risk of your portfolio.

For example, although it is risky to own (i.e., to be long) one stock in a particular industry, and it is risky to short one stock in the same industry, it may be less risky to do both at the same time. As Investopedia notes, this strategy, called a pairs trade, is often used by professional investors to hedge against sector and overall market risk.

For more on this general concept, see, for example, this essay by Ken Hawkins: Make Your Portfolio Safer With Risky Investments.