Avoiding short selling pitfalls

This section is all about applying smart filters to avoid classic short selling pitfalls. Practitioners may hopefully revisit some of those points as they become more familiar with short selling. Most of the points here come from painful experiences.

Liquidity and market impact

Liquidity is the currency of bear markets. If you cannot get out of a position without significant market impact, you do not own anything. It owns you. The way to approach liquidity on the short side is radically different. On the long side, liquidity increases as more investors are drawn to rising prices. Early birds end up selling to a much larger pool of market participants.

On the short side, when investors liquidate their positions, it is a one-way street. After a beating, they don't come back for round two. Nothing captures the emotional journey of long market participants more faithfully than the Kübler-Ross model. Market participants grieve...