Traders who shorted stocks won big in 2022, according to S3 Partners, as the move had a return of 30.8 percent, meaning short sellers outperformed the broader market which suffered its biggest losses since 2008.
To understand the gains, one has to remember that the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite lost 8.8 percent, 19.4 percent and 33.1 percent respectively last year.
Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, wrote that the US short sellers tallied $300 billion in mark-to-market profits on average short interest of $973 billion.
But even with the huge win in 2022, short sellers still lag in recent history. In the past five years, an average annual return for short sellers was a loss of 4.4 percent while the Dow gained 6.8 percent, the S&P 500 rose 9.3 percent and the Nasdaq climbed 12.5 percent.
It’s worth noting that the total amount shorted last year was below 2021, when the $1 trillion threshold was broken, but higher than in 2018 through 2020.
Short sellers still needed to be good stock pickers in 2022 as different sectors and individual holdings could produce vastly different results, Dusaniwsky said.
For instance, the best sector to short last year was beat down communication services stocks, which produced a return on shorted holdings of 56.7 percent. Energy was the worst, and posted a 28% loss on shorted holdings, S3 Partners said.
Short-term and long-term performance are typically inversed. That’s because investors usually move short on holdings that they expect to lose value, so energy — which was the only winning S&P 500 sector in 2022 — would not be a target for shorting as investors watched share values rise despite the broader market’s decline.
And choosing sector orientation is “only half the battle” given the variety of stocks within each one. Within consumer staples, for example, Beyond Meat had the biggest return on short selling at 128.2 percent. French fry producer Lamb Weston was the least profitable in its sector, and lost 43.9 percent.
Carvana, which was beat down as used car demand slid, had the best short performance of all stocks with at least $100 million in short interest, recording a 377.6 percent gain.
On the flip side, Madrigal Pharma was the worst to short. Bets against the company lost 345.4 percent. The stock rallied in December on the back of well-received drug trial data.
What is short selling?
Short selling is an investment or trading strategy that speculates on the decline in a stock or other security’s price. It is an advanced strategy that should only be undertaken by experienced traders and investors.
Traders may use short selling as speculation, and investors or portfolio managers may use it as a hedge against the downside risk of a long position in the same security or a related one. Speculation carries the possibility of substantial risk and is an advanced trading method. Hedging is a more common transaction involving placing an offsetting position to reduce risk exposure.
In short selling, a position is opened by borrowing shares of a stock or other asset that the investor believes will decrease in value. The investor then sells these borrowed shares to buyers willing to pay the market price.
Before the borrowed shares must be returned, the trader is betting that the price will continue to decline and they can purchase the shares at a lower cost. The risk of loss on a short sale is theoretically unlimited since the price of any asset can climb to infinity
When an investor sells a stock short, they borrow shares from a broker and sell them in hopes of buying the stock back later at a lower price. It’s a tactic that does best when the broader market is hurting. Short seller returns came in below the major indexes when the market gained value in 2019 through 2021, but beat the averages when they ended the year down in 2018.