A short seller with a 95% win ratio shares 5 stocks he recently traded and why his strategy of finding cash-strapped companies to bet against is working better than ever

Our experts answer readers’ investing questions and write unbiased product reviews (here’s how we assess investing products). Paid non-client promotion: In some cases, we receive a commission from our partners. Our opinions are always our own.

• David Capablanca uses multiple criteria before shorting a stock.
• This year, market volume has dropped from where it was in 2020 and 2021.
• This reduces his risk of being short squeezed.

In 2016, David Capablanca was on his way to becoming an architect after completing a graduate degree at the University of California, Los Angeles.

That same year, he became interested in stock trading. He began practicing short selling, which is the process of borrowing a stock to sell and repurchase at a lower price in order to pocket the difference. During the first few years, he traded a few hundred dollars at a time to hone his skills and get a feel for the stock market.

However, by 2020, he noticed that chart patterns began to deviate from their usual patterns. He claimed that micro- and small-cap biotech and pharma firms with no fundamentals were spiking by hundreds of percentage points in a single day.

The volume of retail traders and stimulus checks pumped into the market caused stocks to move in response to as little as a Reddit post or tweet. However, Capablanca recognized that the moves were unsustainable and determined that being on the other side of those trades by shorting could be a profitable strategy.

Because of higher volumes, you could make a lot of money in the market in 2020 and 2021, but it was much riskier because you could get trampled by retail traders buying stocks and holding them, according to Capablanca.

The change in trading behavior had an impact on charting patterns that seasoned traders used as guidelines to enter and exit a trade, making price movements more difficult to predict, he added.

Being a trader, according to Capablanca, entails constantly adapting his criteria to the changing market environment. Small cap stocks haven’t been as volatile this year, according to Capablanca. According to him, the majority of the stock market’s gains have come from the magnificent seven mega-cap technology stocks, while the rest of the market has been slow.

While there is less money to be made, he believes there is less risk of drastic price moves against his positions.

While the trades are more predictable, the returns are less substantial. On the other hand, if a trader suffers a larger loss today, it will be more difficult to recover because there is less volume.

Overall, he believes that calmer price movements and less retail-driven activity are benefiting his short-selling strategy more than ever.

In July, his win ratio was 94.91%, according to TraderSync, an online trading journal that tracks performance. TraderSync’s chief technology officer, David Olivares, examined Capablanca’s account against his Interactive Broker statements and raw trades obtained via the Interactive Broker API, as well as some transactions from his Cobra account in July. Olivares estimated a 2% margin of error. As of November 2, his win percentage was 95%. Capablanca previously used up to seven trading accounts but has recently reduced them to five.

In previous interviews with Insider, he discussed the various criteria he uses to determine whether a stock is suitable for shorting. They include, among other things, a sudden price swing, a news catalyst, float size, and dilution. When he examines a stock’s chart, he looks at the volume-weighted average price (VWAP), which rises with volume and then falls.

Dilution

He now primarily shorts companies that have no cash. And there are many of these in a difficult economic environment.

This aspect of his strategy entails searching for potential dilution. This is more likely to occur when a company’s cash reserves are less than three months. It raises the likelihood of a stock offering or At The Market Agreement (ATM). When a company issues new shares, it dilutes existing shareholders. Capablanca will use a tool to track dilution if a stock suddenly begins to rally as a result of a news catalyst. However, the information is freely available on company filings.

Long-position traders may avoid purchasing a stock that is at risk of dilution, but a short seller may benefit from this. However, in 2020 and 2021, Capablanca observed that even when a company was short on cash, retail traders would frequently buy the news and hold the shares, preventing the stock from falling. He noted that because demand outweighed supply, share prices were rising even after dilution. The majority of penny stocks he observed rose above a dollar for no apparent reason. As a result, he couldn’t rely too heavily on this information.

He noted that because there are fewer traders, demand has decreased, causing dilution to have a greater impact in dragging a stock’s price down.

VWAP accuracy has improved.

The volume-weighted average price (VWAP) is a chart line that represents the average price paid for a stock by traders. It is calculated by multiplying the number of shares purchased (volume) by the share price and then dividing by the number of shares purchased.

It is widely used by traders to determine support and resistance levels. If a stock’s price is significantly higher than its VWAP, it indicates that it is overbought, and vice versa. During years of high volume, a stock’s price can rise far above the VWAP. Trading high-volume stocks became extremely risky as a short seller struggled to predict when the stock would reverse.

A share price is now more likely to encounter resistance above that line. He claims it is no longer a wild animal.

Even more short sellers

This year, there is one caveat for short sellers. While the risk of being trampled by a stampede of retail traders has subsided, he noted that the short side of the trade has become more crowded.

How does this look on a graph? The first part of the trade often appears to be going as planned: a catalyst sends an unsuspecting stock soaring before it begins to fall. However, as more short sellers try to drive down the stock’s price, he warns that it may become overcrowded. This effect can be delayed as traders rush to cover their positions or have them liquidated by their brokerage, which often drives the price back up and causes a slight squeeze.

He avoids being short-squeezed by recycling his shares, which means that instead of shorting and riding the stock price down for a longer period of time before covering, he shorts and covers multiple times. When his position is squeezed, the exposed position shrinks. This allows him to feel more at ease while trading, which leads to better decisions.

For example, Reviva Pharmaceuticals Holdings (RVPH) appeared on his radar on October 30 after rallying by more than 40%. He looked up the stock and noticed that it had phase-three news, which attracts larger institutional investors because it shows that the company has passed earlier phases. This was a sell-the-news event for Capablanca, but the company only had one month of cash before it needed to raise more.

This was a sell-the-news event for a short seller like Capablanca. He confirmed his theory after the stock dropped to $2.31, or roughly 40%, from its previous day’s close at around 8:18 a.m. By 9:00 a.m., its share price had increased by 80% to more than $5 before forming a double top, a technical pattern that indicates resistance. Capablanca began shorting the stock at a price of $5 to $5.20 per share.

He started covering his position at $4.75 and recycled his shares by shorting and covering as the share price fell further, using the previous day’s close of $3.75 as a support line. He covered his previous position for $3.86. He isn’t trading the stock right now, but he will keep an eye on it if it rises again.

While some short sellers develop a strategy centered on trading a single stock, Capablanca trades a variety of stocks based on what appears on his radar after a 40% rally and/or if he receives a promotional text or email about it. These businesses are also vulnerable to dilution. They are as follows:

On October 23, he received a text message about InMed Pharmaceuticals (INM). The following day, the price increased. However, it was a cash-strapped stock. And on October 24, they made a $5.2 million private placement.

CEL-SCI (CVM) came onto his radar after rallying on October 23. He couldn’t think of a compelling reason for the spike. The company was running low on cash.

Momentus (MNTS) experienced a 139% increase on October 12. Without strong fundamentals, it rallied significantly above the VWAP.

The trading of Pop Culture Group (CPOP) stock was halted on October 31 after the stock quickly rallied. It appeared on his radar while it was stopped. He had a few minutes to go over the inventory. It had no cash and a history of pumping and dumping in recent years.

These are some of the things he’ll be looking at in November.