Oops, James, typos in my first response to your post made it look pretty silly. And I discovered it after my 15 minutes expired.
In particular, a sentence about January effect etc. somehow wandered to the wrong paragraph.
Below is a corrected version of my post.
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Using decades of historical data, the SPX goes up an average of 10% per year. So shorting the index is gambling with the odds stacked against you. The most you could hope for is that you are so much more clever than the rest of the world in guessing which way the whole market will go that you can make up for the 10% annual upward bias.
Lots of luck.
My approach to shorting stocks is to include a small percentage of shorts in my mostly-long portfolio for the primary purpose of hedging the portfolio and the secondary purpose of making profits. To make this work, I must pick stocks that are more likely than the average to go down, and I must diversify among several small short positions to reduce the risk.
In his book What Works on Wall Street, O'Shaugnessy backtested lots of different simple mechanical methods of picking stocks, and found that the one that had the poorest returns was picking the stocks with the lowest one-year relative strength. The returns were positive, but in the low single digits.
His demonstration is what leads me to broken stocks as an attractive target for short selling. In addition to O'S's single criteria mechanical screen, I attempt to add additional filters, such as bad financial statements and discounted convertible financing, to identify better targets. With the exception of certain market periods, like the January effect, and last summer when shorts everywhere were getting their clocks cleaned, this seems to work pretty well.
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