What Are Weak Shorts?

Weak shorts refer to traders or investors who hold a short position in a stock or other financial asset who will exit at the first indication of price strength. Weak shorts are typically investors with limited financial capacity, precluding them from taking absorbing too much risk on a short position. A weak short will generally have a tight stop-loss order in place on the short position to cap the loss on the short trade. Weak shorts are conceptually similar to weak longs, though the latter employ long positions.

Understanding Weak Shorts

Weak shorts are more likely to be carried by retail traders rather than institutional investors since the retail trader's financial capacity is limited. That said, even institutional investors may find themselves in the weak-short camp if they are financially stretched and cannot afford to commit more to trade.

The presence of weak shorts may intensify volatility in stock because weak shorts will be inclined to exit their short positions if the stock shows signs of strengthening. Such short covering may drive the stock price up rapidly, forcing other traders with short positions to close them for fear of a short squeeze.

If the stock begins to weaken and is vulnerable, the weak shorts may reinstate their short positions. Weak shorts may be constrained by the availability of capital but may still have a high degree of conviction in their short strategy. Heavy shorting accentuates the stock's weakness, driving its price down quickly, a trading pattern that leads to stock volatility.

For a retail trader that is day trading or swing trading, a weak short is a positive. By exiting early when a stock no longer looks weak, the trader limits their risk and saves their capital for the short trades that are acting weak but are profitable.

How to Bet Against Weak Shorts

Traders often look for stocks with heavy short interest, a contrarian indicator to identify stocks poised to move up on a short squeeze. Stocks that are heavily shorted by retail investors are better short-squeeze candidates than those held by institutions with deep pockets, such as hedge funds.

One way to identify retail short interest is by using trading software that shows major holders of the stock and block trades. A stock with (a) minimal institutional holdings, (b) few block trades, and (c) significant short interest is likely to be one with a disproportionate number of weak shorts.

Traders can wait for the price to strengthen, potentially moving above a key resistance level where many short-trade stop-loss orders are placed. A trader initiates a long position in anticipation of a further rise as weak short traders are forced out of their position.

Weak Short vs. the Put/Call Ratio

Puts are another way to bet on a declining stock price. The put/call ratio measures the number of puts bought versus the number of calls, those that profit if the stock price rises. The ratio indicates when traders have become extremely bearish or bullish on a stock. This can be used as a contrarian indicator that a reversal in price may be forthcoming.

Limitations of Using Weak Shorts

It is hard to predict the number of weak shorts and difficult to decipher if the short positions are held because the stock is falling. Whether weak shorts or not, these traders are in the correct position to profit, and buying into them may be foolish.

Trying to force weak shorts out of a position, causing a price pop, may prop the price up temporarily, but unless positive news, fundamentals, or technicals emerge, additional buyers may not decide to enter and the price will continue to fall.

Weak shorts are a strategy that can't be measured with great accuracy, therefore it's unknown exactly how many weak shorts there are or how weak they are.