Is your stock on the 'hit list'?

By Michael Brush

Want to know if your stock is about to get hammered?

See if it's on a new short-selling "hit list."

No, this hit list isn't something out of an episode of "The Sopranos." It's a list, available for free, of stocks that are among the biggest targets of short sellers, those often-savvy speculators who bet that certain stocks will go down.

Short sellers place bets by borrowing shares and selling them at today's prices. They're hoping the stock will tank so they can buy shares back at a lower price later, repaying the loan and pocketing the difference.

This hit list is compiled daily by a relatively new Web site called LocateStock. Its job is to connect investors looking to sell shares short with investors who want to make money by lending out shares.

While serving as matchmaker (for a fee), LocateStock learns which stocks short sellers crave the most. The list gives you an inside look at this important piece of market intelligence.

How do you use that information? The obvious way is to short the stocks yourself -- a risky practice but one that does carry big potential rewards.

The other way is as a tip sheet of potentially troubled stocks you own or want to buy. It's not a definite sell signal -- a short player can be wrong, too -- but it is a definite sign that someone thinks he knows something you don't.

The inside track

What LocateStock shares with the public at its Web site is big. It's the kind of insider information that until now was available only at prestigious Wall Street brokerages that also act as matchmakers -- giving them a similar read on stocks in demand by short sellers. It's rarefied information because the stock exchanges are still stuck in the Stone Age. Astonishingly, though we can easily see data on stock purchases in real time, the exchanges release data on the size of short positions in a stock only once a month.

LocateStock gives you a daily read on the stocks that short sellers are going after today. "We are the leading indicator," Web site founder John Tabacco Jr. says.

LocateStock is another example of how the Internet and technology are democratizing Wall Street, bringing lower commissions, more widely available data and other welcome changes. Now it's shining a light on the world of short selling.

About 70 billion shares changed hands via LocateStock last year. Tabacco, working with former Securities and Exchange Commissioner Harvey Pitt, expects to launch a version of LocateStock for bigger market players, called Lendex, in a month or so.

LocateStock shares its hit list -- and company officials spent hours talking with me about how the system works -- to market its services to short players. But why not use it anyway? Checking the hit list is free and simple. Just look at the High 5 list on the site's home page and the stock tickers running across the screen. (I'll tell you how to read these tickers, and explain other ways to mine the Web site, in a moment.)

The site's main drawbacks: The hit list won't give you a read on every stock out there, and it's not 100% effective.

But the list has a great record thus far. "When the shorts are lining up, that usually means a stock is going to come under pressure," Tabacco says. Consider these examples:

• In early April, Lehman Bros. (LEH, news, msgs) stock shot into the mid-$40 range from below $40 a share in part because the bank announced it had raised $4 billion in capital. Tabacco was skeptical because Lehman Bros. stock was one of the most sought-after short positions. It had been a regular on the High 5 list for nearly two weeks. He said so on Fox News. Since then the stock has fallen more than 40%, trading recently for $24 a share.

• Early this year, E-Trade Financial (ETFC, news, msgs) had been hammered to well below $5 a share from more than $23 last summer. But in early February, the stock traded up to $5.50, in part because of the widely praised baby ads launched during the Super Bowl. Tabacco was negative on the stock because of strong demand from short players. Shares recently traded for $3.50.

• Likewise, in early January, when MBIA (MBI, news, msgs) traded above $15 a share, it looked like a stock worth shorting despite a 70% plunge in the previous three months. The reason: It had been making regular appearances on the High 5 list. Recent price: $5.

An overall look at the performance of stocks after they hit the High 5 list paints the same picture. LocateStock was launched in March 2007. By the end of the year, 75% of High 5 stocks were down from the first day they appeared on the hit list. Shorting all stocks on the High 5 list as soon as they appeared would have brought a 16% return by the end of the year, after LocateStock transaction costs, according to Tabacco. (Excluding LocateStock fees, the group was down 20.4%.) During the same period, the Dow Jones Industrial Average ($INDU) advanced 9%.

Playing the short game

As I see it, there are four ways you can use LocateStock:

Check the High 5 list. This is the fastest way to use the site. On the home page each day, you'll see a High 5 list of stocks that short sellers want the most. If a stock you want to buy appears there, be careful. The stock might decline.

There is a catch, though. High demand to borrow a stock generated by just a few sources won't put a stock on the High 5 list, even though demand could be huge. The reason: LocateStock doesn't want to lose clients by tipping their views to the market. So it won't put a stock on the High 5 list unless there are requests from more than 20 players. The site also won't reveal a stock in high demand if it has no supply to satisfy that demand. So the list is not an indicator for the whole market.

Continued: Check the ticker

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