Smart Retail Traders, Short Sellers, and Stock Returns

Abstract

Using short sell transactions data from 2010 to 2016, this paper is the first to provide a comprehensive sample of short selling initiated by retail investors. We find that retail short selling can predict negative stock returns. A trading strategy that mimics weekly retail shorting earns an annualized risk-adjusted value-(equal-) weighted return of 6% (12.25%). Their predictive power is beyond that coming from retail investors as a group or from off-exchange institutional short sellers. Our results suggest that retail short sellers can profitably exploit public information, especially when it is negative. Retail short sellers also tend to be contrarians who provide liquidity when the market is one-sided due to (institutional) buying pressure.

Keywords: Short Sell, Retail Investors, FINRA, Return Predictability, Liquidity Provision

JEL Classification: G11, G12, G14, G20