Improve Your Shorting Performance
(this is from a piece in our Yamner University and will be sent out with our free weekly e-newletter. Subscribe by sending an email to tdesk@yamner.com with the words SUBSCRIBE in the subject.
Improve Your Shorting Performance
While both buys and long sales require an intimate knowledge and accessibility to a broad range of trading systems and technologies, nothing is more demanding of a traders' attention than shorting stocks, particularly Over-The-Counter (OTC) issues. Once a client decides to short a security, there are several components to ensuring that the trade is done skillfully to obtain the best results.
Borrow the Stock!
First, in order to short a stock, the stock must be borrowed. Since you are selling stock that you do not actually own, you must ask your firm to borrow the stock from its inventory or that of its clearing firm. When you short the position, you are actually selling the borrowed stock. You are selling the stock first in the hopes of being able to buy back the stock later at a lower price. You will be short (negative) the shares in your account until you buy back the shares to cover the short position. When you buy back the shares, and cover the short position, you deliver back the shares you have borrowed and your position is then flat.
If you can not borrow the stock from your broker dealer or their clearing firm, you can not short the stock. Therefore, even though you may want to initiate the position and feel strongly that the stocks' price will fall, you may not be able to take the short position because no stock is available to borrow. The firm or their clearing firm may not have inventory in the position sufficient to allow you to short the security. This is often the case with smaller firms that use smaller and less-established clearing firms.
I have heard many investors and traders discuss the limited availability of short stock and their inability to obtain positions they had wanted. I can not speak to the size of inventories at other firms or their clearing firms, but I can speak to our position. Yamner & Co., Inc. clears through Pershing, a division of Donaldson Lufkin Jenrette, both large players in their fields. As a result, we often have far greater access to inventory than many other firms. Smaller firms, particularly those that clear through small, less expensive clearing firms usually do not have the availability afforded by Pershing and DLJ.
These others firms typically have smaller inventories because they have smaller accounts and clear through smaller clearing firms. Most hedge funds, mutual funds and other large investors do not feel secure with their assets at smaller clearing firms. In a review last year with The Street.com, Gary Smith, a position and technical trader, highlighted Yamner & Co., Inc.'s greater access to stock inventory as a contributing factor for our being his top choice for traders.
Borrow it for the day!
Some firms require that clients make their requests to borrow stock along with the actual order to sell stock. This can make the process difficult, as the trader may not know the availability for shorting until significant time and effort have been spent in tracking and analyzing the position. At some firms, you submit your request to borrow when you actually place the trade, whether by phone or computer. Often, this occurs after a stock has acquired much interest from other short sellers. As a result, it is more likely that since your request has not come until late in the day, you may not be able to obtain stock.
To remedy this, see if your firm will permit you to borrow the stock earlier in the trading session, perhaps pre-open, and hold the stock for your future use during the day. For instance, Yamner & Co., Inc. permits clients to email us pre-open a list of stocks for shorting. We will then borrow the stocks for each clients' potential use later in the day. This assures our clients that they aren't wasting their efforts in watching and evaluating positions only to find the stocks are unavailable for shorting. Our clients borrow and reserve their positions and then can later decide whether they want to place their orders.
Executing Short Transactions
Once the stock has been borrowed, it is critical that the client understands the complexities of the many trading execution systems, the position that their firm could be taking in the trade, particularly in light of the exacting rules regarding shorting stocks. Simply, you need to be with a firm that offers the highest quality executions and is willing to work your order for you. Using a firm that works your order becomes even more important when considering the transactional complexities of shorting stocks in the Nasdaq marketplace.
As in all trading, you need to have fast access to the firms' trading desk, access to multiple execution systems and routes, including ECNS and auto-execution systems. Many readers of our thread are familiar with our sentiment regarding the importance of being with a firm that offers the highest quality executions rather than simply the most affordable commissions.
“You need a firm that is willing and capable of working the order”.
Similar to listed securities, there are regulations that govern how and at what prices and in what conditions a stock can be shorted. Several years ago, in order to minimize the impact of short sellers in disturbing market operations, the exchanges instituted rules regarding short selling stock.
In addition to the requirement that the stock be borrowed, as discussed above, stocks can only be sold at certain prices relative to the inside market. Listed stocks adhere to the up-tick rule while OTC stocks follow the up-bid rule. Lets focus on OTC stocks.
The up-bid rule generally states that an OTC can only be shorted on an up-bid or at a sixteenth greater than a down-bid, or when the spread is equal to or less than the sixteenth, it can be shorted on the offer. For more complete details, please see the NASD's websites at nasdr.com, or nasdaqtrader.com.
What does all this mean?
For example, lets assume that an OTC stock, ABCD is quoted at 20bid x 20 3/8 offered. The client begins watching the stock and is becoming interested in shorting the position. The stock begins to falter and before the trade can be entered and executed the stock's quote changes. It becomes 19 15/16 bid x 20 ¼ offered. This 19 15/16 is considered a down-bid. The current bid at 19 15/16 is less than the prior bid. Many quote systems graphically represent this with up or down-arrow next to the bid on quote line.
The up-bid rule means that the seller can not simply hit this bid to effect a short sale. Infact, even if the stock were to remain 19 15/16 x 20 ¼ for the balance of the day, with no change in the stock, it is quite likely that at many firms the client might not receive an execution regardless if the order was sent to short sell at the market, with a limit of 19 15/16 or even lower.
In this scenario, at this particular moment, the trade must be executed at 20 or greater. With trades going off at 20 3/8 and 20 ¼, most investors would start to question why they are not complete having not received an execution report. Unfortunately, firms are not required to work your order, to display a constantly changing, dynamic offer for you. Rather, in my experience, most firms simply wait for the first up-bid before filling your order, regardless if where it comes, regardless of how far the stock falls before the up-bid comes. Most online firms simply non-discriminatorily route your order to market makers who, as their name states, makes markets and act as principals in your trade. So while they may sell out of inventory to clients at various prices in between the bid and ask, they will not fill you until the bid were tick up. All the while you will be seeing such prices and wondering why you have not been filled.
The stock, though, might not sit tight. In fact, if you are good in spotting a downturn thus driving your interest in shorting the position, the stock might simply tank. As it falls, the market maker, regardless of the prints and executions occurring at the offer or in between, is under no obligation to fill you until the bid were to tick up. Thus the stock, though it could be printing at 20 1/4, 20 1/8 , 20 1/16, might continue to fall and you may not receive an execution for several 1/8ths, 1/4s, if not more. If the stock were to fall to 18 ½ x 18 5/8, then stabilize, and then move up to 18 9/16 x 18 5/8, the firm may fill you at 18 9/16 on your short order. Meanwhile, buyers had been buying all the way down and it is unfortunate that without a firm working your order, you had no opportunity to fill at these higher prices.
This is not to say that you couldn't have been filled in between the bid ask spread when you first entered your order. To have that happen, you need to have a firm work your order. You need to be with a firm that works your order or with a direct order entry firm which offers you the necessary access for working the order yourself. For example, when you first entered the trade, with a quote of 19 15/16 x 20 ¼, the stock can not be sold at that moment at 19 15/16 because it this is a down-bid.
Yet, you could have worked the order yourself if you use a direct order entry firm and have the understanding of the systems and technologies. You could have a firm like Yamner & Co., Inc. work your order, offering the stock at 20 1/8 or 20 1/16 or even 20. Again, a short sale can be done at a sixteenth above a down-bid. If the stock were printing at 20 1/8 and 20 ¼, there is a strong likelihood that once you were to make it your offer at 20 or 20 1/16, it would fill. That is, with your offer, the stock would be quoted 19 15/16 x 20 1/15 (your offer). You would have the cheapest offer and someone interested in buying at 20 ¼ would take your stock at 20 1/8 first.
If no one were to take your stock and the stock were to begin falling you would continuously adjust your offer downward. All the while if you were to see an up-bid, you could then hit that bid. You have nothing to lose by making it your offer awaiting an upbid to hit.
The market always goes to extremes, thus when a stock begins to fall, it usually does so quickly and with great intensity. When a stock is tanking, usually it is quite difficult to find up-bids to hit. As well, when the stock first turns up after a sell-off, this is usually where the stock will rebound somewhat, however short-term. Short-term, this is not when you want to see your order getting filled on a short order.
While clients of direct order entry firms such as MBTrading or ABWatley can manage their own shorts, if they have the understanding of the rules' complexities and trading systems, most online discount firms do not give investors access to trading systems, to ECNs or auto-fill systems, nor offer the service of working an order for the client. These clients are missing invaluable components of short selling .
I have often stated that Yamner & Co., Inc. performs best, achieves the greatest degree of price improvements, when handling the shorting of OTC securities. While we do quite well and have earned a reputation as one of the best trading desks on the Street, we are particularly well suited for performing short transactions.
Shorting stocks can be extremely risky and can expose the investor to unlimited losses, yet can be quite rewarding as well as offer a reasonable hedge against other positions in an account. Nonetheless, several complexities require greater attention to this particular type of order. Investors should ensure they borrow stock early in the trading session and aggressively work their orders to obtain the best prices. Doing so, one can greatly enhance the performance in short selling financial securities. |
