Excellent reading on hedge funds and short-selling

Sad to say, but many hedge fund managers are illiterate dolts. They are wealthy, illiterate dolts, so there are compensatory attributes, but they’re still nasty sorts to be stuck with at a party.

That is why it is nice to run into brights folks like short-seller Jim Chanos. He runs a billion-dollar New York-based fund that is totally devoted to short-selling — that is, it invests such that it stands to profit if certain stocks fall.

The preceding is, of course, an exceedingly difficult & dangerous business. Why? Well, consider the following:

  1. Stocks naturally trend upward over time as economies grow. Running contrary to that pressure is like swimming upstream against a very strong current.
  2. There are rules that make short-selling difficult, like the so-called up-tick rule. In essence it means you can’t sell a declining stock until the prior trade was higher than the one before it. The idea is to create “bear raids”, but the effects are very different.
  3. Your maximum gain is “only” 100%, but your maximum loss is unlimited. After all, a stock can fall to zero, but it can ascend to any number.

There are other reason why short-selling is a perilous business, but those will do for a starter. You can see, however, how successful short-sellers are very different breeds of cat: individualistic, contarian, stubborn, and so on. They have to be.

To get a look at that difference in action, have a read of this document. It is Jim Chano’s testimony to a hedge fund hearing in Washington this week. A better explication of the business, you will not find, including a fascination section on how Chanos got involves early on with selling both Worldcom and Enron short. Did I mention it is well-written and interesting too?