Shorting stocks is nothing new, but recent volatility in companies like GameStop (NYSE:GME) has shown the dangers of crowded short trades. As prices rise, short sellers are often forced to buy back shares, creating a feedback loop that sends shares even higher. That makes the most shorted stocks particularly vulnerable to “short squeezes,” creating super-normal profits for quick-thinking buyers.
Frequently Asked Questions
1. What are Shorted Stocks?
Investors can profit from falling share prices by selling shares of companies they don’t own. By borrowing shares from someone else, these investors essentially “owe” stock to someone else and eventually need to buy back the shares. Meanwhile, any dividend payments must still get paid to the original stock owner.
When shorted stocks go down, that means short-sellers can make money by closing out their position (i.e., buying stock) at a lower price. But price rises can quickly bankrupt a short-seller if they aren’t properly hedged. Unlike buying, shorting stock has almost unlimited downside since shares could theoretically rise infinitely.
2. What Stocks Are Heavily Shorted?
Hedge funds tend to favor shorting stocks of weaker companies in competitive industries. Often, that means looking at companies in retail, or at biotech companies with questionable drug candidates. But occasionally, short-sellers will also target high-priced shares of growing companies, hoping that valuations will eventually come back down.
Heavily shorted stocks are often quite volatile; short-sellers are often in it to make quick money, and fast-moving shares provide greater opportunities. But some blue chip companies also get shorted as a market hedge for funds looking to maintain a market-neutral position.
3. How Are Stocks Shorted?
Most people can short shares through their brokerage once they get proper clearances. Hedge funds, meanwhile, will often use multiple brokers to build a larger short position.
Keep in mind that short-sales also involve an interest payment — the harder the shares are to find, the higher the fees will be. These can range anywhere from 1%-2% for highly liquid companies to 30%-80% for harder-to-find stocks. So, when deciding which highly shorted companies to buy, make sure your brokerage is sending you a part of the interest payments that are due to you.
