What to do when your shares are heavily shorted

If the professionals are betting against you, how should you react? Panic? Hide in a hole? Fight? Here's some advice.

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Shorting is an investment activity that's usually the domain of professionals and the bane of retail shareholders.

Fund managers who short a stock will make money if the price goes down. It's hardly an endorsement for the company.

So what happens if you read that a share that you own has been shorted?

Forager Funds chief investment officer Steve Johnson recently addressed this dilemma in a company video. 

Here's the good news

For any share that you purchase or hold, you need to research both the pros and cons of the company behind it.

This means a report from a short investor is a non-emotive way to educate oneself about the risks, according to Johnson.

"We always want to know what the bear case is on a stock if we've got a strong bull case, and understand why people on the other side are selling it."

Johnson said fundies who short a stock are usually pretty public about their concerns. Perhaps they're motivated to speak out in order to push the price down.

"You can go and get the report, you can read it, do your own research and work out whether you think they are right or not."

Perhaps you agree with the short case and decide to sell or not buy.

Huge upside

But say you disagree with the short investor and you hold onto the shares. 

According to Johnson, if the heavily shorted stock surges in value it'll be a better windfall than other shares.

Why is this?

"The big upside in these stocks is that when they are wrong, it can cause a surge in the share price in a very short period of time as they're all rushing to get out of their positions."

Johnson said the level of short interest in each ASX stock is published on the exchange's website.

"It's a really good idea if you are researching something on the long side, go and have a quick look at how big the short interest is.

"Then you can usually Google a short interest report about the company that you're looking at. It's an interesting way of seeing the bear case."

Forager Funds runs the ASX-listed Forager Australian Shares Fund (ASX: FOR). Its share price is up more than 15% for the year, trading at $1.36 on Wednesday afternoon AEDT.

Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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