Rino International: 6 Lessons for Investors

Typically the stock does not fall by 50% on the first day, so be grateful that you have a chance to get out. While it is too late for this advice to be of any use to those who got burned on Rino, I hope it will be a valuable piece of advice going forward because I am sure this is not the last of the short seller attacks.

Lesson #2: Distinguish between a genuine short attack and simple online gossip

On virtually every stock investor board, there are numerous unfounded postings about fraud put up by people trying to cheapen the share price so they can buy in. I see these all the time and don't take them even slightly seriously. The report by Muddy Waters obviously took months to prepare, was very coherent and was 30 pages long and widely disseminated. This is substantially different than a simple baseless fraud claim on an investor chat room.

So to repeat, be very afraid of the professional organized short attack but ignore the random "F" word that is often bandied about in chat rooms. Any serious short seller isn't going to rely on Yahoo! Finance to get his message across.

Lesson #3: Short selling looks profitable but is still a highly dangerous game

The fundamental problem with short selling, in contrast to going long, is that you can only make a profit of 100% whereas your losses are truly unlimited. By contrast, I have made several hundred percent on a number of Chinese stocks and never lost more than 50%. Back in 2009, I almost shorted shares of one of my least favorite companies, China BAK Battery (CBAK) The company is a perpetual money loser and will inevitably have to continue diluting shareholders if it wants to survive.

I was very close to shorting this stock when a rumor surfaced that CBAK was going to get a contract with Google (GOOG). The shares jumped 65% in one day. I would have received a margin call and locked in a permanent loss and not even benefited when the stock fell back down. In short, if you're going to short a stock, you had better be very certain that you have momentum on your side and monitor the position literally every minute, including in pre-market and after hours and be ready to close out at the first sign of a short squeeze.

Lesson #4: Put options are not efficient for crisis shorting

The primary advantage of put options is that you pay a fixed amount of money for the option, so that unlike short selling, your loss is limited. However, the key variable is the price that you pay for the options. I have been following Rino put options for the past week and the implied volatility is more than 200%.

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