In this morning’s AM meeting I joked about the fund’s that were caught short in today’s gap up in DKS. Whenever I come across a stock that is heavily shorted like a DKS I try to put myself in the shoes of the people who think it is worthwhile to get short such a stock.  It isn’t hard for me to imagine the rationales that are presented by the hedge fund analysts to the traders at the large funds that are looking for good short opportunities to balance their portfolios.  

Rationales To Short DKS:

1. It is in the consumer discretionary sector which should be struggling in the middle of an awful recession.
2. The internet has driven down margins in the retail sector and lowered barriers to entry for competitors.
3. Retail is a really tough sector with little margin for error.  So much comes down to merchandising and if a firm makes a misstep they will get crushed.

I am not an analyst.  I make my living by observing the price action in the market and discerning tradeable patterns from that price action.  But I have observed a few bigger picture items over the years when doing my morning preparation, which includes checking the short interest in the stocks that I trade each day.

1. Companies that have a specific niche and connect with their customers tend to do well over time.  They really frustrate those who are shorting them.
2. These companies are fairly easy to spot because they are noticeably different than their competition and if they have a physical storefront attract very heavy foot traffic.
3. Here are a few examples: Best Buy (BBY), Chipotle (CMG), Netflix (NFLX), Whole Foods (WFMI) and Bed Bath and Beyond (BBBY).
4. I have had some first hand experience with each of the companies listed above.  They tend to annihilate their competition or don’t really have significant competition in their space.
5. Their competitive advantage is understanding their niche and delivering a product or service to their customers in a positive way.
6. The only time to consider shorting one of these stocks is when a competitor enters their space and shows a similar level of prowess.

How do I use the above information to make money?  I wait for a stock like DKS to report a better than expected earnings number and I focus on getting long if the price action in the premarket and Open is even mildly bullish.  These are the types of trades where my intraday risk/reward tends to be be less than 1:5.