Advice on Short-Selling, Volatility - TheStreet

Editor's note: Here, Scott Rothbort replies to questions he has received from readers.

J.R.:

Where can I learn about short selling?

Rothbort:

There is no one book or class that I can recommend that solely focuses on short selling. However, I have written several articles that cover the topic:

"How Short Selling Works"

"Three Strategies Every Short Seller Must Know"

"Three Risks Every Short Seller Must Know"

"Five Arbitrage Techniques Every Investor Needs to Know"

"How To Outperform the Market and Manage Risk With ETFs"

You can also refer to

TheStreet.com's

updated

Short Selling section

.

A.G.:

What is your most recent list of worst-managed companies?

Rothbort:

For the past two years on

RealMoney

, I have published a list of the worst-managed companies in the U.S. I find that these companies tend to perform poorly and may even wind up in

bankruptcy. Here is the 2007 list -- by sector:

Technology:

Palm

( PALM) -- The consumer smartphone market was Palm's to lose. Just like the Mets in September 2007, Palm has failed to deliver even a small victory.

Palm had

Research In Motion

( RIMM) by the throat when RIM was paralyzed by the

NTP litigation

. Instead, Palm blew a product introduction in Europe. The Foleo product introduced to much fanfare in May was scraped in September. Next, along comes

Apple

(AAPL) - Get Report

with the iPhone and now Palm is "taking on water" really fast.

The funny thing is that Palm makes a great smartphone for consumers. I was very happy with my Treo 650 and I recently upgraded it to the Treo 750 with the

Microsoft

(MSFT) - Get Report

operating system.

Retail:

Circuit City

(CC) - Get Report

-- While

Best Buy

(BBY) - Get Report

has broken the mold and finally built a successful electronic retailer, Circuit City is trying to best emulate The Wiz (which was last owned by Cablevision

(CVC)

before it closed for good) or Crazy Eddie (without the fraud). Circuit City seems to be the takeover-rumor-of-the-week --

every week

(see "

Blockbuster Goes After Circuit City

").

The problem with Circuit City is that unlike

Home Depot

(HD) - Get Report

and

Lowe's

(LOW) - Get Report

, or

Target

(TGT) - Get Report

and

Wal-Mart

(WMT) - Get Report

, there does not seem to be room for both Best Buy and Circuit City to co-exist. In this sector, Best Buy is the innovator and Circuit City is the imitator.

Cable and Telecommunications:

Charter Communications

(CHTR) - Get Report

-- As cable television, Internet, VOIP and the whole "triple play" telecom package grows in popularity, Charter has managed to deliver its own triple play of operating losses, excess

leverage and

cash flow burn to its shareholders. As hard as it is to say, even Charter can make Cablevision look good.

Entertainment:

Six Flags

(SIX) - Get Report

-- Six Flags is trying to make its parks more socially conscious and in doing so it has become less investor friendly. This company is also adept at operating consistently at a loss and burning cash. Six Flags relies on coupons and discounting to attract traffic. That is never a recipe for success. With debt piled on top of debt Six Flags' destiny may be in bankruptcy court.

Financial Services:

Washington Mutual

(WM) - Get Report

-- Every Washington Mutual customer and former employee that I speak with does not hold the company in high regard. Neither do investors, since the five-year price return for the stock is just about zero. A track record of bad

acquisitions might be the explanation.

Even

Citigroup

(C) - Get Report

, which was management-challenged with

Chuck Prince

at the helm had some positive stock price returns.

B.P.:

Would you include

Johnson & Johnson

(JNJ) - Get Report

in the same "big-cap pharma" group as

Pfizer

(PFE) - Get Report

,

Merck

(MRK) - Get Report

and

Schering Plough

( SGP)?

Rothbort:

No. I would exclude Johnson & Johnson but grudgingly. I am no fan of the pharmaceutical sector, outside of the generic drug and selected biotech businesses. I think that

big cap pharmaceuticals are a decaying breed.

These large pharmaceutical companies have patents which have or are about to expire for drugs that contribute billions of dollars in revenues to the companies. As the patents expire, these drugs are then formulated and sold by generic drug companies like

Teva Pharmaceuticals

(TEVA) - Get Report

. I own exposure to Teva indirectly through my holdings in the

First Israel Fund

(ISL)

.

On a positive note, Johnson & Johnson along with

Abbott Labs

(ABT) - Get Report

have diversified beyond pharmaceuticals to consumer products, diagnostics and other product lines. Meanwhile, the same cannot be said for Merck, Pfizer or Schering Plough, which are pure drug plays with eroding patents.

R.G.:

You wrote on

RealMoney

, that December 31, 2007 through March 20, 2008, the S&P 500 declined 9.46%, and since March 20, the S&P 500 rose 4.74%. You mentioned that this movement is one way of proving that periods of continued levels of low volatility is a bullish sign, while extreme levels of volatility is a bearish sign.

Would you comment on volatility as a function of turns in the market? I've noticed "choppy action" at the top when the market is turning from

bull to

bear, as well as "choppy action" at the bottom when the market is turning from bear to bull.

Is volatility a sign of a turn (either way) rather than an indicator of bear markets? Or, is volatility a function of the hope that bulls have of turning a bear market and not vice versa?

Rothbort:

Volatility is not a straightforward concept. I would like to point you to "

Understanding the Four Measures of Volatility

."

What you define as choppy action could be buying or selling being exhausted during short-terms tops and bottoms. My research indicates that longer term tops and bottoms have volatility indicators, which build up over prolonged periods of time and are not apparent in short-term indicators, such as the

VIX

I:VIX

.

Furthermore, short-term periods of volatility, similar to what I pointed out above for the first quarter of this year, are often mistaken as longer-term trends.

Finally, volatility is a "mean-reverting" phenomenon that requires attention. Mean reversion is the theory by which prices, returns and risk will migrate back toward the mean (average). Definition of that mean is important. What you need to do is put it in the context of some time frame. For trading purposes, many people will use the notion of

moving averages

to define the mean.

To send a question to Scott Rothbort, click here.

At the time of publication, Rothbort was long C (small legacy positions), AAPL, ISL and RIMM, although positions can change at any time.

Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele.

Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.

Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Term Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.

For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at

www.lakeviewasset.com

. Scott appreciates your feedback;

click here

to send him an email.