Covestor model manager Michael Arold attempts to exploit market inefficiencies using a momentum-based trading strategy. He has a strong engineering background and currently lives in Germany. He manages Covestor’s Technical Swing model, which follows this strategy:
Using multiple technical indicators, Arold surveys movements in the market at the sector and stock level. He takes a discretionary view of trending stocks and sectors, based on the fundamentals of likely moves in the opposite direction. Short term model.
Arold recently sold short LDK Solar (NYSE: LDK), so we asked him to share his investment thesis. His response follows.
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China based LDK Solar (NYSE: LDK) has fallen significantly this month. I was targeting the very weak solar sector, looking for a trade with a compelling risk/reward ratio. On May 13, I finally sold LDK short.
When taking on short positions, I look for weak stocks in weak sectors. Solar stocks had been struggling in the second quarter: Guggenheim’s Solar ETF (NYSE: TAN) has lost significant value so far this month. LDK has been even weaker.
According to FinViz.com, 15.3% of LDK’s float is sold short (as of 5/25), a high amount. Often, investors take high short ratios as a positive, providing an opportunity for a short squeeze. However, academic research by Drake et. al. has shown that high short ratios combined with bullish analyst sentiment are in fact bearish for a stock. The rationale is that short sellers are usually more sophisticated and analysts tend to be “behind the curve,” downgrading a stock after it experienced significant declines. LDK is a good example: Kaufman Bros. downgraded the stock from buy to hold on May 20. The downgrade was published after the stock had lost a huge portion of its value over the prior two months.
In April, 12 analysts maintained a “buy” rating on the stock while six recommended to “sell,” so one of the conditions I’m looking for, bullish analyst sentiment, was met.
On May 13, LDK broke an important technical support level, which was my call to action to enter the short position.
Sources:
TAN and LDK share price performance from Google Finance, https://www.google.com/finance.
FinViz data: http://finviz.com/quote.ashx?t=ldk
“Should Investors Follow the Prophets or the Bears? Evidence on the Use of Public Information by Analysts and Short Sellers” Drake, Rees and Swanson. The Accounting Review, 8/25/10. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1269427
LDK analyst ratings information from Yahoo Finance, https://finance.yahoo.com/q/ao?s=LDK
