Page 252 - THE MARKET WHISPERER

248 PART 8 - Shorts: Profit From Price Drops

According to Yahoo, the quantity of CHKP shares sold short for the
particular date checked is 3.9% of all CHKP shares. Is that a lot? Not
much? It makes no difference. Firstly, the information is not precise: it
relates to data received via brokers several weeks earlier! Secondly, this
data contains no details that allow you to reach any conclusions about the
stock’s anticipated direction.

Example
Let’s say a company called ABC has a high quantity of shorts.

• Does the large quantity of traders executing shorts on the stock mean
that the stock must drop?

• Or does it mean that with so many shorts executed, the shorters
eventually needing to buy the shares in order to return them to the
owner will cause the stock to rise?

• The answer is: both situations can occur, and it all depends on timing.
The truth is that for a company losing value, with its price plummeting

towards zero, it may get to that point irrespective of the quantity of shorted
shares. The reverse can also occur: if there are a large number of shorters
and for some reason the stock begins to rise, shorters will panic since
they will need to buy high. As a result, short covering may begin: shorters,
pressured by the need to return the shares and seeing the price rising,
will need to “cover” open shorts. You can never know what is happening
behind the scenes without checking the stock chart. And this issue brings
us to the next, very important topic.

Short Squeeze

Occasionally a situation called a “short squeeze” occurs. Let me describe
a true event concerning a stock that for a very long time traded at around
the $2 to $3 mark.

The company was known to be having difficulties, and therefore, as can
be expected, there were a large number of shorters involved who believed
that the company would close and the stock price would drop to zero. In a
surprise announcement, some good news surfaced and the stock shot up
overnight from $3 to $5. This panicked the shorters, who had entered close
to the $3 point. Some, especially those using a high margin, woke up the
next morning to find they were holding a losing position and were forced
to close those positions by buying while the price was rising. The more
the price rose, the stronger the avalanche of shorters closing trades. Every
price rise caused increasing numbers of shorters to close losing trades.