What are weak shorts?
Weak shorts refer to traders or investors who hold a short position in a stock or other financial asset and will exit at the first indication of price strength. Investors who are soft shorts usually have low economic resources, which prevents them from taking on excessive risk in a short position. A weak short will often have a tight stop-loss order in place temporarily to limit the loss of a fast transaction. Though weak longs use long positions, soft shorts, and weak longs have conceptual similarities.
Understanding Weak Shorts
Due to their limited financial resources, individual traders are likelier than institutional investors to carry weak shorts. However, if they are strapped for cash and cannot increase their trading commitment, institutional investors can find themselves in the weak-short category.
Weak shorts tend to abandon their short positions if the stock shows indications of strength, which might increase stock volatility. The stock price may rise quickly due to this short covering, compelling other traders holding short positions to close them out of concern for a short squeeze.
The weak shorts may reopen their short bets if the stock declines and shows signs of vulnerability. Soft shorts are confident in their short approach despite possible financial restrictions. Excessive shorting highlights a company’s flaws and rapidly lowers its price, a trading strategy that increases stock volatility.
A weak short is advantageous for a retail trader who is day trading or swing trading. By quitting a stock early before it loses more value, a trader may reduce risk and conserve money for lucrative short bets that seem weak.
Investments in stocks or other financial assets with a high degree of weak short-term presence are often more volatile than those with a lower degree of weak temporary presence.
How to Place a Bet on Weak Shorts
To find companies about to rise on a short squeeze, traders often search for equities with high short interest, a contrarian indication. Stocks owned by organizations with large budgets, such as hedge funds, are not as good candidates for a short squeeze as those widely shorted by individual investors.
Using trading software that displays block transactions and the stock’s big holders is one method of determining retail short interest. A reserve is likely to have a disproportionate number of weak shorts if it has (a) few block transactions, (b) few institutional holdings, and (c) substantial short interest.
Traders may bide their time until the price gains momentum and breaks through a significant resistance level, often used for short-term stop-loss orders. Then, they take a long position, expecting weak short sellers to be driven out of the market as prices increase.
Comparing Weak Short and Put/Call Ratios
Another option for betting on a falling stock price is to use puts. The put/call ratio calculates the difference between the number of calls—stockholders who stand to gain—and the number of puts—purchases. The ratio shows the points at which traders have become exceptionally optimistic or bearish about a company. This may serve as a contrarian signal that a price reversal will occur.
Consequences of Employing Weak Shorts
Estimating the number of weak shorts and determining whether the short positions are maintained due to the stock’s decline is challenging. Buying into these traders may be unwise since they can profit whether or not they are weak shorts.
The price may rise momentarily if weak shorts are forced out of a position. Still, it will likely fall further until more buyers decide to join the market due to unfavorable news, fundamentals, or technical indicators.
Because weak shorts are a problematic method to quantify, it is impossible to determine soft shorts’ precise number or strength.
Conclusion
- A trader with a weak short position plans to quit the job rapidly should the price begin to rise.
- Bullish traders purchase stocks with a high degree of short interest and soft shorts in the hope that the price will climb, driving weak shorts to purchase and higher prices.
- Institutional investors are less likely to be weak shorts than retail traders.
- Weak shorts help retail traders by allowing them to manage their losses and get out if the price increases to a predetermined point.
