Volatile Market Tempts More Into Selling ‘Short’


It was hard to lose money in the roaring 1990s bull market, yet one group of investors lost a bundle.

Professional “short” sellers--traders who bet against the market, convinced that stocks are overvalued and sure to fall--suffered such bruising hits when share prices kept rising that many of them simply went belly up.

But don’t tell Jim Dieveney that you can’t make money shorting stocks.

Dieveney began selling stocks short for the first time in his life in April after watching his portfolio shrink by 25% during Nasdaq’s spring meltdown.


A short sale is the opposite of a normal stock trade. Rather than buying a stock on the hope it will rise, a short seller borrows shares and sells them in the hope their market price will tumble.

If the stock indeed falls, the short seller profits by replacing the borrowed shares at a lower price.

“In the last two or three months, since the [Nasdaq] drop in March, it’s been easier to make money shorting,” said Dieveney, who has shorted Internet giants Yahoo Inc. and CMGI Inc. “Any bit of bad news can really drop a stock.”

All but written off as a hopeless strategy in the 1990s, short selling is again on the rise--thanks in part to fearless small investors. Accustomed to lush profits derived from tech stocks’ surge since 1997, some of these investors either don’t want to wait for the next market rally--or don’t think it’s coming. Instead, they’re wagering against the market, sometimes by shorting the same tech stocks that they once owned.


If they’re right, they can make handsome profits in a short time because stocks typically sink a lot faster than they rise.

“If you’ve got a short position, you can wake up and turn on the computer and find you’ve made a lot of money,” said Bill Buerschinger, a Toluca Lake computer programmer who has recently shorted Yahoo, Inc. and Rambus Inc. “If I’m going to be in the tech game, I want to be where the big action occurs, which is on the short side.”

But critics worry that amateur short sellers may be the ones who end up taking a fall.

If the travails of professionals have proved one thing, industry experts say, it’s that profits are elusive in short selling, while huge losses are frequent. They point out that even with Nasdaq’s steep slide in spring, many short-selling pros are managing only mediocre returns this year.

“Some of the short interest we’re seeing is from individuals who don’t know what they’re doing,” said Harry Strunk, a short-selling consultant at Morgan Keegan Inc. in Palm Beach, Fla. “They see something in the [Internet] chat room and away they go.”

Shorting on Nasdaq Has Skyrocketed

Though there is no accurate breakdown of who, exactly, is shorting stocks at any moment, the brokerage industry reports total short-sale figures each month. The data show that shorting of Nasdaq stocks has rocketed over the last 18 months.

Nasdaq short interest--that is, the number of shares borrowed and sold in short bets--stood at a record 3.16 billion shares as of mid-September, up 34% this year and up 75% since early 1999.


Shorting of New York Stock Exchange stocks, by contrast, has risen relatively little since late 1998, though total short interest did reach a new high of 4.31 billion shares in mid-September.

The mechanics of short selling are fairly simple: An investor borrows shares of a stock from his or her brokerage firm and sells them in the open market, immediately pocketing the proceeds of the sale.

The investor hopes the stock will fall in price so that the borrowed shares can be replaced with shares bought at a lower price. The short-seller’s profit is the difference between the initial sale price and the price paid to replace the shares.

Though the bet may be simple, short selling is among the riskiest investment strategies--potentially even more dangerous than the wild Internet-stock buying that became an obsession for many small investors in recent years.

The reason: Though someone buying a stock can lose no more than the amount invested, a short seller faces theoretically limitless losses if the shorted stock soars instead of falls.

Some small investors are learning the hard way just how severe a short-selling loss can be.

After shares of Plug Power, a fuel-cell developer, surged from $30 to $156 in three weeks early this year, one investor said he shorted the stock as it began to fall back.

His logic was that the stock was vastly overvalued, pumped up by frenzied enthusiasm over the idea that fuel cells, which are cleaner-burning than other energy sources, would be in strong demand amid environmental awareness.


But after losing half its value in four days, Plug Power began another ascent to near its old high within a month. The investor, who asked that his name not be used, lost $50,000 when he finally relented and bought back the stock to repay the shares he had borrowed.

“I decided, ‘It has to come down,’ he said. “I waited it out and it just kept going up and up.”

Professionals’ Portfolio Hedge

Short selling, however, isn’t always a pure bet that a stock’s price will decline.

Some Silicon Valley executives use shorting as a way to guard against a plunge in their tech-heavy portfolios: Having some short bets provides a hedge should their portfolio sink.

Wall Street arbitragers--traders who specialize in takeover stocks--regularly use short-selling strategies in their trading.

Experts also say a fair amount of the increase in Nasdaq short selling has come from professional hedge funds, which are investment funds known for taking measured risks.

Among individual investors, only the most aggressive are likely to be trying their hands at shorting. And many who do so say they’re betting only a small portion of their assets and are taking precautions to limit potential losses--for example, by using offsetting trades with stock-option contracts.

Nevertheless, a surprising number of individuals say that after religiously buying tech stocks in the late 1990s, they’ve recently turned to shorting some of those same tech names.

For some investors, short selling feels wrong, almost un-American, even if the bet is correct.

“I hated to do it. It went against all my principles,” said one investor who had owned shares in Microsoft Corp. for years. “But I shorted Microsoft and did well.”

The heightened shorting interest among individuals can be seen in the money flows at the Rydex mutual fund group, which caters to aggressive small investors.

Since the end of August, assets of the Rydex Arktos fund, which shorts the tech-dominated Nasdaq 100 index, have surged 41% to about $136 million. In contrast, assets of the Rydex over-the-counter fund, which goes “long” on Nasdaq tech giants, have held steady at $2.9 billion.

For many investors, the decision to short stocks is much more than a simple shift in investment strategy. It’s more akin to switching sides in a war between very bitter enemies.

Companies and their shareholders detest short sellers, saying they spread lies to yank down stock prices while frequently masking their identities to avoid being held accountable for what they say.

Indeed, it’s true that short sellers are notorious for their tactics. Professionals are known for covertly leaking to the media negative information about a company they have shorted, while amateurs usually hide behind the anonymity afforded by Internet chat rooms.

However, short sellers insist their main mission is to expose the truth, whether it’s refuting a company’s bogus accounting, deflating company hype or simply pointing out gross overvaluation of a stock.

For example, Jack Garrett, a hedge fund manager in New York, is shorting Yahoo in his personal account. He argues that the stock’s spectacular gain last year was thanks to little more than breathless “momentum” buying by investors who knew nothing about the basic business.

The stock is “still tremendously overvalued” despite falling two-thirds from its late-1999 high, he said.

“I love that stock in a sick, perverse way because [the profit from the short bet] has paid off all my student loans,” Garrett said. “When I can’t find out what the [company] does by its name, it’s a [shorting] candidate,” he said, half-jokingly.

Chat-Room Rumors, Disguises and Lawsuits

The battles between short sellers and the companies they target can become so pitched that a few companies have hired private investigators or filed lawsuits to flush out the identities of short sellers.

San Diego-based Titan Corp., for example, filed a suit in August alleging that short sellers had spread bogus information about the company through written reports, Internet message-board postings and media leaks. The company’s stock has slumped from $44 in June to $16.50 as of Friday.

The rumors were started by professional short sellers and spread wildly through chat rooms, said Marshall Grossman, a Century City attorney representing Titan, a diversified technology company.

The message boards “provide a virtual Internet theater where people can yell ‘Fire!’ and [spur] innocent victims into a mad dash for the exits,” Grossman said.

In theory, short sellers can wield enormous power over a stock. The very act of shorting, after all, puts downward pressure on a stock’s price.

But in practice, short sellers’ power is limited. With major tech stocks, the number of shares sold short is typically a fraction of the total shares outstanding.

What’s more, short sellers can be their own worst enemies: If a stock rises instead of falls, short sellers who suddenly scramble to buy back shares to repay their loans can help drive the price dramatically higher.

Partly because of such “short squeezes,” short selling netted mostly losses for professionals in the late 1990s.

On average, the 10 short-selling pros whom Morgan Keegan’s Strunk tracks regularly have lost money for five straight years. This year, they’re up only 7.3% through July.

A separate index of 12 short managers compiled by hedge fund consultant May, Stone & Caddis in Newport Beach shows that only half are profitable this year.

Years of losses had made many pros leery of shorting the highflying stocks that previously had hurt them, so generally they weren’t short the stocks that sank the hardest in Nasdaq’s spring downturn, experts say.

Even now, many of those pros remain very cautious, experts say. “Until they see the whites of [tech stocks’] eyes, they’re going to keep it close to the vest,” Strunk said.

Hedge funds, however, have become more active as short sellers. There are more than 6,000 hedge funds, up from 4,700 in 1995, according to Van Hedge Fund Advisors International.

Though just 1.5% of the funds focus solely on shorting, hedge funds often short stocks in the normal course of business, and need to prove to potential clients that they can make money in all sorts of markets, experts say.

And if the stock market continues to gyrate as it has this year--with rallies often followed by sharp downdrafts, as in August and September--more investors are almost certain to be drawn to short selling, analysts say.

In the late 1990s, “speculators believed Nasdaq was going only one way--up,” said Joseph Toms, president of Hilspen Capital Management, a hedge fund in Burlingame, Calif. “Now, with April and May behind them, they realize there’s a downside and they’re saying, ‘How do I profit from the downside?’ ”

That’s exactly what more individual investors are asking.

James O’Brien, a small investor in Redondo Beach, has shorted several Internet and biotechnology stocks this year, figuring they’re far overvalued and due for a fall.

“I’d like to see order restored to the market,” O’Brien said. “And if it’s going to be restored, I might as well enjoy it on the way down.”


The ABCs of Short Selling

Investor Jane Doe has a hunch that sales at Dot-Com Technology Inc. are going to weaken and that its stock is likely to plunge when the market finds out. So Doe decides to sell “short” 200 shares of Dot-Com. Here’s how the transaction would work, and the possible outcomes:

* The Sale: In her online trading account, Doe submits a regular “sell” order for 200 Dot-Com shares. Because she doesn’t own Dot-Com stock, the brokerage recognizes it as a short sale. The firm sells the shares at Dot-Com’s current price of $60, crediting the $12,000 in proceeds to Doe’s account.

Behind the scenes, the brokerage has borrowed the shares from other customers or from other brokerages. Investors and firms that are long-term holders of stock frequently agree to allow their shares to be borrowed for short-sale purposes, because they are confident the shares will be there if they need them.

Doe is $12,000 richer, but the proceeds from the short sale don’t earn interest, unlike other funds she may have on deposit at the brokerage.

* Scenario 1: Doe has guessed correctly, and Dot-Com’s shares fall a week later to $50. She has $2,000 in paper profit on the transaction. She decides to close out her bet and take the profit.

To close out the short sale, Doe would submit a “buy” order for 200 shares at $50, or a total of $10,000. Her brokerage would return the borrowed shares to the account that lent them, and Doe would keep the $2,000 difference between the two transactions as profit.

* Scenario 2: Dot-Com has fallen to $50, but Doe decides it could decline much more sharply. She decides to wait. There is generally no time limit for returning borrowed shares in a short sale.

* Scenario 3: Doe’s bet has been dead wrong: Instead of falling, Dot-Com’s shares have surged since she sold the stock short at $60. The price now is $70. Doe decides she can’t take the risk that the stock will continue to rise.

She closes out her short sale by buying 200 Dot-Com shares at $70, or a total of $14,000. She has lost $2,000 on the trade.

* Scenario 4: Though Dot-Com rises to $70, Doe believes it will sink again. She decides to hold on, even though she has a paper loss.

But within a week, Dot-Com stock has soared to $100. Doe can’t take the pain anymore: She closes out the trade by buying 200 shares at $100, or a total of $20,000. Doe has lost $8,000 on the trade.

Does Short Selling Hurt Stocks?

Short selling can, of course, help drive down the price of a stock. But short-sale data have to be taken in context:

* Compare the number of shares sold short with a company’s total shares. Consider Yahoo Inc., for example. About 28.6 million Yahoo shares are now sold short. But that is barely 5% of the company’s 549 million outstanding shares.

* Compare the number of shares sold short with average daily volume. An average of 10 million Yahoo shares trade each day, meaning that if all short sellers had to cover their bets by buying back shares, they theoretically could do so in less than three days.

* Note that a big short position in a stock can be bullish. Unless a company goes out of business, investors who have sold short eventually have to buy the stock to repay their loans. That buying can work to drive the price higher, especially if the stock is already rallying.

Where to Get More Information

To find the number of shares sold short in any major stock, go to ( Under the “Quotes” banner in the upper left corner, click “Fundamentals,” then click “Short Interest.”

Sources: Times research, Nasdaq


Short Selling the New Economy

Here’s a sampling of technology and Internet-related stocks, and how the number of shares sold short in each has changed since December. Also shown is the year-to-date change in each stock’s price. In the case of some stocks--such as Qualcomm--a decline in the stock this year has caused some short sellers to close out their winning bets, so the number of outstanding shares sold short hasn’t grown much.


Total shares Pctg. chng. sold short in short YTD pctg. Ticker (mid-Sept., position since change in Stock symbol in millions) Dec. 1999 stock price CMGI CMGI 15.5 +65% --80% Yahoo YHOO 28.6 +57 --58 WorldCom WCOM 29.0 +39 --43 Oracle ORCL 30.9 +30 +41 Intel INTC 47.1 +28 +1 Global Crossing GBLX 34.6 +20 --38 AMZN 32.3 +19 --50 Cisco Systems CSCO 52.0 +14 +3 E-Trade EGRP 27.2 +10 --37 Qualcomm QCOM 10.4 +1 --60 Nasdaq total 3,161 +34 --10


Source: Bloomberg News, Times research


Betting Against Nasdaq

The number of Nasdaq-listed shares sold “short"--that is, shares borrowed and then sold by traders who are betting that prices will fall--has rocketed over the last year, and is up nearly 20% just since the tech sector’s spring plunge.

September: 3.16 billion shares

Source: Bloomberg News