Jaguar in the Tree: The Best Advice of a Seasoned Short Seller

Marc Cohodes explains his meticulous short-selling process

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Sep 21, 2018
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Marc Cohodes, a living legend of the short-selling game, reflects the deep grain of individualism emblematic of his trade.

Almost exclusively a solo operator, Cohodes is a “free-range” trader who makes money on his own book. He is not exclusively a player on the short side (few are), but he has made his reputation by identifying deeply troubled, and sometimes outright fraudulent, businesses and pointing them out to the market that usually did not even know there was a problem.

Despite all the regulations and enforcement agencies now involved in securities markets, many companies have still found ways to misstate their financial and operational realities. Cohodes’ track record is a living testament to the market’s exploitable inefficiencies.

Caution is key when hunting the jaguar

In one of his most famous discourses on short selling, Cohodes discussed the steps he takes in order to avoid getting burned:

"It’s difficult to have hard and fast rules. When you short stocks, you get involved on a carnival ride that's called 'anything goes,' which includes buy-ins, manipulations, fake tenders, and all sorts of shenanigans which can cause stocks to gyrate in a crazy fashion. Before I short anything, I have a few protections. First, I always assume the short can double on me. I size the position accordingly. Second, I guard against ‘thesis creep.’ If the thesis changes, you better get the hell out. If you don’t, you'll clearly get buried. As long as your thesis is pretty good and your analysis is right, you can hang in there. Third, I never, ever, ever get involved in what I would call open-ended situations. I've never been short a drug company that can theoretically solve a big problem. I have avoided pie-in-the-sky names. To use an analogy, I’m not interested in climbing into a tree and wrestling the jaguar out of the tree. I'm interested in someone shooting the jaguar out of the tree, and then I will go cut the thing apart once it hits the ground.”

Cohodes’ analogy of the jaguar in the tree has become a staple of contemporary trader discourse. While it is most popular among active short sellers, it is known and understood by most players in the game. It is a valuable lesson. When selling short, patience is crucial. But it is just one piece of puzzle. Short-sellers must take many precautions in order to avoid getting burned or trapped.

Preparation before the hunt

The visceral imagery of the jaguar in the tree is wonderful in itself, but it can distract from the fact that it is just one of four necessary precautions. Before ever taking a position, short-sellers must first provide themselves with a margin of safety in case the stock moves in the wrong direction. Even a temporary upward spike can prove disastrous if the short-seller has failed to establish enough financial cushion to weather such moves. After all, it is well-known that the market can at times stay irrational longer than overstretched traders can stay solvent and in the game.

Cohodes also warns against shorting particular types of stocks. The particulars of the “open-ended situations” that make some stocks dangerous to short can vary. A popular cult stock may, for example, defy gravity even after deteriorating fundamentals or other serious issues are revealed. Such stocks can be infuriating for short-sellers, who not only see the problems, but also know that the market sees them too. The market can react in strange and bizarre ways when it is dealing with a beloved or much-hyped stock. Short-sellers playing such stocks must be prepared to wait a long time before the laws of economic gravity finally pull it back to earth.

These cult stocks are not the only dangerous shorts. Indeed, companies that could end up doing something transformative (or at least substantial), even if the probability is low, can blow up a short position in the event that things do indeed go in the company’s favor. Developmental biotech stocks, for example, often move on binary catalysts. A short position on the wrong side of such stocks can get nasty very quickly. Better to avoid this class of stock if one wants to enjoy a long-term career on the short side.

Facts are everything

Finally, short-sellers must remain aware of the facts on the ground, not only as they were when they initiated their short position, but as they evolve throughout the trade. “Thesis creep” can sink investors and traders on the long side as well as the short, but it is short sellers who seem most psychologically predisposed to suffering from it. It may come from the fact that taking a short position is almost of necessity a decision to row against the prevailing current. The short seller tends to be sure of their thesis and may start to ignore new facts to the contrary in order not to confront their strategic error. The unwillingness to address the facts and to respond to changing realities can make a bad situation far worse.

It is vital that short-sellers maintain awareness of the facts. As the famed stock operator Bernard Baruch pointed out, a dispassionate assessment of the facts as they stand is the basis of every sound investment decision, whether shorting or going long a stock.

Not a path for everyone

It is important to remember that the path of the short-seller is often a lonely one. It can also be a thankless task (besides the monetary rewards of being right, that is), with companies and their boosters fighting tooth and claw to protect their narratives from the prying eyes of fact checkers. And it takes a lot of work. There may be no better way to conclude this note on Marc Cohodes’ approach to shorting than to heed his cautionary words on what it takes to win at short selling:

"If you're interested in shorting stocks, it's very labor intensive. You probably have to do 6x the work that the longs do. You have to have the courage and faith in your work. I used to say, 96% of the time, you go home feeling and thinking like you're an idiot, and you get paid 4% of the time. So when you have a good day, you have a great day. But your bad days are numerous. It takes a certain mind and mindset to be able to deal with that. Most people just can't.”

Disclosure: I/We own no stocks discussed in this article.

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