Monday, February 08, 2010

Critical post regarding short selling pumps in light of NXTH today!

In trading, it pays not to confuse OUTCOME with play soundness.

All too commonly, traders, driven by human nature, do this.

Consider NXTH, and its story today.

The price action purely, for most of the day, seemed to suggest that for at least another session or two, the party would continue. It did not. After climbing slowly for days at the rate of a cent or 2 per hour, in a spectacular fall it nosedived in successive candles a great deal.

Early shorts were squeezed but later rewarded (if still holding and having met margin requirements, if applicable) for their daring. Congrats to all those who banked coin on this play. I am glad they did well.

However, I agree with Tim Syke's initial argument that getting in short in front of the signs of immediate collapse is quite questionable. Practical details get in the way otherwise that can lead to drastic outcomes.

Ask the folks who shorted MXC early in 2008. From 5 to 50 dollars  per share! You can even ask the folks who were right about the tech bubble several years ago who went broke on margin before they could prove it. They were right, but each top seemed to be the final gasp, and it outlasted their bankrolls.

If a person shorts and gets lucky, they look like Sean Payton did in calling a low % success rate play of early onside kicking in the Super Bowl, if it FAILS it was the dumbest thing he ever did and what was he thinking! People forget the logic, they just notice what appears to be the outcome. They become blinded by the call.

Obviously, the conundrum resides in obtaining shares from the broker used to short early enough so that getting them from competitors is realistic, but relying on your knowledge of being right in the end, your research, etc. is a tempting game to play but this is a method which can have its drawbacks.

Not everyone can solve this, unless they are very well capitalized or have taken a small position, by deposit of significant funds on demand to their broker, hoping to ride out a squeeze to victory and look like a genius.

Now, if your broker allows share reservation, like TOS, things might work better, which you can do each morning a stock seems in play, like NXTH.

Sykes botched the play himself and made money with an entry a lot later (so it appears) than early bird shorts who took considerable risk but had a bigger potential reward.

Going long early (some days prior) on NXTH might have been possible with a smaller position, constant (and I mean watching every tick live) monitoring, with a market order sell all order at the ready in one mouse click.

Today, AFTER the snail mailer has been in play for at least a day or two, a sign that the party may end soon, that was a risky strategy in and of itself.  Relying on stops here would be optimistic, expecting a fill when it tanks so rapidly.

Nevertheless, if a long player bought on open and took profits after decent gain of over 15%, they would have been fine, and their chest beating would again prove the theory of this post, which is that you can never confuse OUTCOME with play soundness. I am sure there are several longs who did not get killed today and day traded this stock, banking coin and living to tell about it, but that does not make their play a great idea!

Due to the practical problems of margin requirements and bigger than anticipated squeezes (see MXC and tech bubble above) it pays statistically over many plays to wait UNTIL certain key levels are breeched or in the case of a top quality pump like NXTH, the dump begins in earnest and you jump in pronto.

No, you will not make as much, but you avoid being wrong, (or more likely, early enough to be margin called out before you can prove how right you are) and still can bank coin. NXTH went up over a MONTH straight last year before diving 50%. If this go-round had as much gas left, early shorts might be proven right AFTER going broke on margin or being unable to deposit the required funds to wait out the squeeze in going for gold.

As it was, NXTH only went up 7 sessions straight, when the fall rewarded early birds.

One method such early birds might use to permit such an early position short is hedging on opposite sides in 2 accounts and jettisoning the long hedge ASAP in the long position account when the dump is in its nascent stages. Only commissions and slippage would be lost, hopefully, in the main.

That would address the vexing problem of being early vs. not having available shares when it came time to enter the party. I respectfully argue that waiting, trying to reserve shares for later use, is a sounder strategy.
NXTH could as easily have continued squeezing for days, as it could have collapsed on this very day. Without at least a hedge in place, the risk is questionable to assume.

One cannot be blinded by the call and in so doing, confuse individual OUTCOME with best odds.

An early short has to do some homework at the very least. One has to consider the account balances being used, position size, the ability to meet margin demands, etc. on a play like NXTH to render judgement of the play within that context. You cannot do it without analyzing your individual situation and applying that to the decision to anticipate the collapse by shorting well ahead of the stampede for the exits.

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