10 secrets to finding stocks to short

Here are 10 secrets to finding stocks to short. Shorting stocks is the art of getting ahead of irrational investors, and if you watch carefully for the signs, you should be able to do like any other investor on Wall Street.

This post is part of an investment series on shorting stocks titled 100 tips on how to short sell stocks.

1. Seek out stocks that have no intrinsic value. A stock with a $10 million market cap and $20 million in debt, for instance, or a company that’s at a competitive disadvantage in a crowded marketplace. Either would be a great stock to short.

2. Wait for a trigger that’s going to push share prices down before you short a stock. If you’re confident an overvalued stock is going to have a disappointing earnings report, wait until that report comes out and sell shares short. If strong companies in the same sector are reporting poor earnings, expect the weaker companies to report poor earnings, too, and short before the earnings release.

3. Good at reading balance sheets? Find the accounting tricks that are artificially propping up a stock. A great example of this are financial stocks that have been able to mark-to-market essentially worthless assets. Two years ago, the banks’ balance sheets looked a lot worse than they do today, but not a whole lot has changed. If the economy tanks, those accounting tricks won’t hold water.

4. Look for companies with mounting inventories. If a company’s stock-piling their wares, that means there aren’t any buyers out there. A company just can’t keep making products no one buys. Eventually, it’ll lead to price reductions, lowered margins and declining earnings. Going short before the broader market recognizes the troubles at a company are the key to locking in big profits.

5. Keep an eye out for insider sales. Inside sales are a normal part of business. If a high-level director at the company needs cash to finance a trip to Belize, he’s justified in selling some company stock. On the other hand, large, million-dollar plus sales don’t happen every day. And if there’s one thing an executive doesn’t like, it’s losing money. If they expect their company’s shares to keep going up, they’re not going to sell. They’ll be begging their uncle for a loan before they do that.

6. Seek out companies with shriveling or negative free cash flows. Companies that have taken on significant acquisition costs or R&D expenses will have lower earnings in the future. If their business model can’t support the research or acquisition, they just might not be able to climb out of the hole, and you can climb right in and make some money.

7. Short stocks in companies with obfuscated 10-Ks or 10-Qs. If a company’s struggling to keep their profits looking good, they’re going to have to come up with some nifty accounting tricks to do it. That means lots more paperwork when they file their annual reports. If you notice substantial increases in page-counts, read the fine print carefully.

8. Low-volume is your friend. If a stock’s moving up or trading sideways on low volume, investors are likely growing complacent or weary of a company. Don’t short a stock that’s climbing on high volume. You could be out of buying power faster than a fresh college grad.

9. If you’re good at shorting stocks, you can make money going long. Have a good track record of selling short? Then, you’re great at identifying when a stock is overbought. On the flip side, that means you can probably tell when a stock’s oversold. Try going long if you’ve had lots of success selling short. Just look for all the signs you avoid when you usually short a stock.

10. Short stocks that have investors in a tizzy (just make sure you wait until the party’s over). Often, a small-cap stock will release news of a huge sale that pushes a stock price up 20 percent or more. If you read the underlying news, though, the fundamentals just aren’t there. It’s not unusual to see share prices pushed up beyond values that the news justifies. For example, if a small-cap stock announces $10 million in new sales, that shouldn’t justify an intraday climb of 20 percent in market cap.

The moral? Shorting stocks is the art of getting ahead of irrational investors. If you watch carefully for the signs, you should be able to successfully short overbought stocks.

This post is part of an investment series on shorting stocks titled 100 tips on how to short sell stocks.

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