Disclaimer is that I do not trade shares. I trade indices and FX.
That said, I was on BusinessDay TV last night and a question was about shorting EOH and my answer was no – only short zombie stocks and now everybody wants to know what’s a zombie stock?
A zombie stock is one that is dying. It may have a busted business model, over weighed with debt, loss making and the like. A stock that we’d frankly be surprised if it survived. These are easy shorts and remove a lot of the risk that comes from shorting stocks.
In recent years AEG and IMP were both very easy zombie stocks, IMP still is.
The risks are simple. Firstly, few stocks go down forever with the overall trend to higher earnings (even if only because of inflation) pushing up prices and this makes going long the easy trade. Secondly massive jumps higher are more frequent then jumps lower. Thirdly with shorts your profit is capped at a 100% down move but risk is uncapped as the stock can go up forever. Lastly falling stocks are often more volatile meaning stops either get hit all the time or need to be extra wide.
Now this is not a perfect science, but if we stick to only shorting zombie stocks, ignoring weak stocks and going long strong stocks we can significantly improve our odds of being a profitable equity trader.
The exception to this rule of course is during a market meltdown. Then short away at the stocks, but do not try and predict the melt down and short everything.