Whole Lotta Shorting Going On

You know what short-selling is, right? It's when you reverse the classic buy-low/sell-high order. You first borrow shares of a stock you're bearish on (through your brokerage) and then sell them, expecting the price to fall. If the price does fall, you buy shares back on the market to replace the ones you borrowed. You'll have collected more from the initial sale than you spent buying the replacements. Voila -- a profit from bearishness!

Most of us are familiar with shorting, but if you're like me, you tend to forget about it for long periods, as you don't engage in it. It's good to keep it in mind, though, as large numbers of shorters can influence the market.

Think of the many stocks on the market about which people are pessimistic. Many of them will be heavily shorted. If the market starts soaring, taking these stocks with them, what typically happens is that some of those short-investors panic, as their would-be gains are transformed into escalating losses as the stock price rises. They'll "cover" their positions by buying shares to replace their borrowed-and-sold ones. Doing so will increase demand for those shares and will therefore push prices up even further. This can prolong or enhance a bull market run.

Meanwhile, if the market environment is more like today's, with many stocks falling, there are likely to be plenty of shorters with big smiles on their faces. Again, though, they may have an effect. If they feel at some point that they've made enough money and further slippage of their stock is not so much a sure thing, they may cover their positions. This can boost the shares to some degree.

There's a record amount of short-selling going on in the market these days. According to a Bloomberg report, total short-interest is up 55% this year, with more than one-third of all S&P 500 companies having at least 5% of their shares sold short.

Companies with heavily shorted shares include:

Company

% of Float Shorted

Beazer Homes (NYSE: BZH  )

69%

Palm (Nasdaq: PALM  )

39%

GTx (Nasdaq: GTXI  )

51%

Big Lots (NYSE: BIG  )

46%

LCA-Vision (Nasdaq: LCAV  )

54%

USANA Health Sciences (Nasdaq: USNA  )

68%

SunPower (Nasdaq: SPWR  )

46%

Source: WSJ.com. Float = total shares publicly owned and available for trading.

Because the overall market tends to rise over long periods, short-selling as a long-term strategy doesn't work well. But if you think a particular company is in trouble, selling shares short is a way to profit from your analysis.

Learn more about shorting and its effects in these articles:

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. The Motley Fool is Fools writing for Fools.


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