Profiting from Short Sellers

To start, short selling is the act of borrowing someone else's stock, selling it on the open market and buying it back at a lower price, therefore making money on the difference.  However, the plan may backfire, and the share price may skyrocket. Then they're in trouble because they HAVE TO buy it back no matter what the price is. The short seller will only make money if the share price falls, while the amount of money they can lose is limitless.

Q: Well if shorters have unlimited liability why do they short in the first place?

1. they know something is fundamentally wrong with the company.
2. the company is in a weak industry or the market in general is weak.
3. other people are shorting it and they're just following the leader.

In my experience, if there's a high short interest in a stock I would definitely do extra DD before touching it. Shorters are resilient and will not go down without fighting. In some really orchestrated short attacks I've seen whole reports (i.e. Alfred Little) written, stock bashers badmouthing in forums, level 2 scare tactics (big walls), and online defamatory articles. So if there's a crap load of shorters, the stock price may be depressed for some time.

Q:  How do I make money if they're constantly shorting the stock?

First make sure there's nothing wrong with the company (i.e. no fraud, healthy business), no external problems (i.e. political unrest), strong industry, etc....Then calculate the short ratio, by dividing the outstanding shares shorted by the average daily volume. A ratio of 2 means it'll take about 2 days to cover all the shorted shares. In addition, the company's attitude towards its share price is important as well. Some may not care and others will counterattack via dividends or buybacks, and that's when the fun starts. The stock will rise 5% or so with a strong news release. The professional shorters that began the short attack will most likely cover and buy back the stock sending it even higher. As the share price increases, shorters will panic or get margin calls forcing them to buy the stock as well. How fast and how big the movement is will depend on the float and volume.

- The Hawk

short squeeze article:
http://alphatrends.blogspot.com/2006/09/short-squeeze-article.html