Shorting small cap overcrowded?
In recent years shorting small caps has gained a lot of traction. if you have been active on Fintwit you would notice a significant increase in accounts tweeting about shorting small caps. Part of me thinks it’s the covid 2020 market crowd figuring out that shorting small caps produces better results than longing for them
Covid market
In 2020 the markets went crazy, almost every small cap with nonexistent fundamentals went 100 % above their original price, and this created a market of extreme FOMO. Dilutive companies would jump on any trend and drop a PR. Suddenly their stock is up 50-300% pre-market. When the market opened a lot of them faded but just many of them held and continued to rally day after day. Eventually, like they always do, they drop an offering and it game over
The volume was so incredibly high, that stocks with 5m float would trade 100m volume on the day they gap up. Short sellers and whoever was longing for it could build a massive position without worrying much about liquidity. The small caps eventually faded and short sellers had it easy after the hype was gone. It was normal to make 50-70% on the fade. Many new traders who aren’t full degens noticed that and started learning how to short-sell
Different market conditions
Fast forward In 2022-2023, the market slowed down a bit, it’s not as hot and stocks don’t gap up crazy like they used to do. We got a market where there could be way more short sellers than their buyers, this created an environment where every stock that goes crazy is of short squeezes, the stock usually paints weakness which piles short on it. Next thing you know it swipes up and everyone is suddenly offside trying to chase the exit, this occurs a lot with low float and it as my friend Yeo calls It, “Short and teleport”
Stocks became harder to trade. They get hit with a kill candle just to soak and reclaim it as if nothing happened, it became the sole intent for whoever is controlling or the as tradethematrix refers to them as “rigger” is to collect as many shorts as possible to swipe them up later. Nate from InvestorUnderground refers to it on his Sunday Scans as “ Being gamified “.
Other than the covid traders turning into short-sellers, there are other factors that helped make shorting small-caps a very popular strategy. One of them being
Traders Success
Thanks to X ( formerly Twitter), Many traders shared their expertise and sometimes their profits (PNL). in doing so they gained a massive following on their socials, people like TheShortBear who ended 2020 with returns of over 892,000%.
yes that’s not a typo, in his interview with Chat with Traders, The short bear whose real name is Lukas Frohlich goes over his year in 2020 and the extraordinary performance that he put on
Lukas is just 1 out of many successful traders who took to Twitter to share their knowledge and executions, there are many others like Nate from Investor Underground, TheShortSniper, Daytradingzoo, Morg..nvm.
Another notable social media success is Humbled Trader. using humor and “Lamborghini money ” she made it to 1.2m subscribers on YouTube. Recently she interviewed a lot of successful traders and most of them were primarily short-sellers like Steven Dux, Kris Verma, and others.
3 of these traders are mainly short sellers and they know what they are talking about. They don’t sell the become a millionaire in a week’s dream. people can see their authenticity unlike others ( I see you gobling gang)
I am not making the case that social media figures crowded the small-cap shorting niche, but the ease of finding information helped in making it a popular strategy, so maybe they did
Easy access to data
with services like Quanted.io, Flash research, and Spiket around, it has never been easier to gain access to years worth of gap-up data which will usually indicate there is an edge shorting small-cap stocks
Using this software, within seconds you can get years’ worth of data from gap ups, percent fade, open to high avg spike and many many more, before any of these was easily accessible, traders had to manually track them in spreadsheets for years.
Popular trading names on Twitter like ADF, heavily advocated for tracking everything about a ticker in play. These metrics included pre-market volume, volume forecasts, float, institutional hold, filings, etc. Nowadays with software like Quanted or Flashresearch, all this information is easily attainable. An argument can be made about this lowering the effectiveness of a strategy while others would argue it has no effect given the nature of dilutive small-cap behavior
Even when it comes to backtesting, manual backtesting took forever and you had to go through so many tickers to get a solid answer about any strategy. now it can be done in less than 10mins
So, has the edge eroded?
Ironically edge erosion became the meme of the week on Fintwit, however, there is some truth in that, some strategies that worked in 2020 do not work anymore, FBO clearout with death candle used to be followed by massive unwind and fade, however now every other kill candle seems to reclaim
However
in my humble opinion, as long as small-caps remain in relatively low liquidity compared to large-caps, forex, futures, etc, we will find inefficiencies to exploit, and that is where the edge comes from. as long as there are human emotions, there will be an edge. stocks might not give clean fades and we might get more swipers and circuit halters but there will always be an edge where there is very high inefficiency
Good luck to you All
