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Editor's note: The following article originally appeared as premium content on our subscription site

on April 7, 2000. We are releasing it to the free site to show

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experience -- and check out a 30-day free trial! The following piece is, in fact, a rewrite of an article James J. Cramer wrote on short-selling last Friday. Cramer will occasionally rewrite

pieces that deal with particularly complex topics. The text of the original piece is in regular facetype, while the text added in the rewrite appears in boldface and parentheses.

The short-selling process seems endlessly fascinating to people.

(True to the lead sentence, this piece received more kudos than any piece I've done since I moved over to work at full time.)

No matter how many times I talk about it, people want more and more and more. They especially want more when we have had a head-slamming up day like we experienced on Thursday, when you know the shorts were laid to waste. Big-time.

(My checks around the Street about Thursday's action revealed that some funds gave up 5% to 6% of their gains for the year that day. They felt an immense amount of pain. As most of our readers are congenitally long, they have no idea how many people left Thursday's market thinking, "What a nightmare." That's what happens when you come in riding a perfectly good short hand and you get sheared without a chance to bring any of the shorts in. Oh, and yes, the terminology for shorting is different from that for buying. When you buy a short you are "covering" a short, or "bringing a short in." You might not say that to your broker -- you don't want him knowing you are short -- but you would certainly say that to your trader.)

People want to know what the shorts

(an abbreviation for short-selling funds)

had to do with the rally, how much of the rally was short-covering, and whether the rally will be sustained after the short-covering is finished.

These are extremely valid questions. Let's take them one at a time. How much did the shorts have to do with it? A ton! There are 10,000 hedge funds

(a hedge fund is a fund that takes a performance fee as well as a management fee. Hedge funds, by law, are only for wealthy individuals, in part because they are unregulated and can pretty much do what they want. Mutual funds are tightly regulated -- although it sure doesn't seem like it these days)

out there and another whole group of funds that are allowed to hedge by buying puts

(a put is an option that allows you to capture the difference between where a security is now and where it falls to. If you own puts on Intel (INTC) and it drops three points, you will profit. You will profit in varying degrees depending on how deep in-the-money or how at-the-money or how out-of-the-money they are. I used to be the biggest options trader on the Street. These days I am not allowed to trade them, so I kind of miss that excitement.)

either on indices or on individual stocks. (Remember the other day I wrote

an article about how the


Needham Growth fund could short and buy puts to protect or hedge itself from the downside?)

Most of these hedge funds are supposed to make money no matter what. In other words, rather than hiding behind their charter as the reason for the pasting they delivered you, these hedge funds were supposed to profit from the downside.

(This was a snide comment meant to chide those funds that are run by managers who claim their hands are tied and they have to do badly for you because you told them that you always want to be fully invested in the most dicey stocks. What a bunch of hogwash. Nobody gives anybody money to lose money. They may want some exposure, but they don't want to lose money.)

Most of the time that means making heavy bets against favorite stocks that are loved by the mutual funds and therefore are most vulnerable to disappointment.

(During the past 10 years, it became a real joke among the professionals that certain mutual funds routinely kept their stocks going up by manipulating those stocks using the giant cash flows that came in over the transom. Now those cash flows are reversed, and these people don't know what they are doing. They claim to know what they are doing, but they turned out to be rank amateurs when the game got hard.)

Often it means selling the



short or buying puts on the QQQs.

(This is an index that represents the continually sagging Nasdaq 100. It is more powerful than the underlying index in that concentrated buying or selling of the QQQs is immediately reflected in the underlying stocks. You go in to buy a million QQQs -- and that is a very easy thing to do, as I have done it many times you're going to cause a whole bunch of stocks to gap up a tad.)

This has been

the trade

since the year began, and when something becomes

the trade

you have to bet that many of the 10,000 hedge funds are doing it.

(At any given time, there is always one trade that everyone has on. At one time it was the "short Nikkei" trade. Another time it was the "long Telmex" trade. Another time it is the "short yen" trade. Another time it might be the "long the short end short the long end," and on and on. If you read Roger Lowenstein's excellent When Genius Failed about Long Term Capital, you'll see how prevalent this kind of thinking is among all hedge funds. Hedge fund managers are an insecure lot and they tend to follow whoever has a hot hand at that moment.)

Many of these funds just sent out their quarterly letters and let people know how they did.

(Some funds report monthly. We reported quarterly, but you could obtain your numbers pretty much whenever you wanted.)

They felt emboldened -- if they made money the first quarter -- to press the bet.

(When you have a successful bet in the hedge fund business, it's hard to take that bet off. You think that it's what caused you to win, so why switch? You rarely think that you're overstaying your welcome.)

So they came in loaded with puts and shorts Thursday, just loaded, because, frankly, it had been working, and most hedge fund managers worship at the Church of What Is Happening Now.

(The long-term but rich people grow impatient if you're not doing well. They grow that way because they don't want to hear excuses about not making money. They also don't believe all of that long-term garbage that the mutual funds have brainwashed you with. They are constantly trying to figure out whether you are on the ball or not, so they can take it away if it turns out not to be true.)

The good news from



(in line with guidance and no further deterioration)


BEA Systems


(will make the quarter and then some)

and the



upgrade from a bear

(Holly Becker, whom I like very much)

instinctively triggered worry on the part of shorts, as the trading in the early morning showed a heavy bias toward QQQ buying.

(Here's something you might not know. Every morning there is intensely spirited QQQ trading of major six-figure amounts. We traded the QQQs almost every morning from 7 a.m. on. They are a much better indicator than the Nasdaq futures.)

But it wasn't until options opened shortly after the market opened that we saw massive put-selling as shorts sought to take profits on their gains of the last few days.

When someone sells puts, it's pretty obvious that he or she is doing the equivalent of covering a short.

(Recall that you can short a stock, and participate in a one for one decline, or you can buy a put and participate in the decline one for one after the premium disappears. There is premium for time, risk and volatility. You buy a put on the QQQ at $35, that is struck at $40 and there might not be that much premium, but there would be a lot of premium if you bought an at-the-money put, right at $35.)

When you're at an institution, all day you will hear flow

(this is a technical term that means you hear what merchandise is being bought and sold. The brokers don't tell you the name of the fund that is buying or selling. That is strictly forbidden. They tell you the size and the stock or index.)

from the options desks.

(Options are traded separately from common stock and they have separate departments.)

On a day like Thursday, I would have expected to hear "QQQ put seller."

(That's pretty much the entirety of what you are able to learn.)

You could then conclude that a short-seller was cashing in his chips -- extremely bullish given that he was right enough to own the puts to begin with.

(We professionals are always trying to gain an edge. We are always trying to figure out whether someone who is hot or smart is taking action. Anybody who had bought puts for this decline we just experienced had a good head on and you want to know that when he is done thinking there is substantial downside. Sometimes option bets in the QQQs are so big that I might jot the bet down, along with the contract that it entailed, and when the broker says "size put seller" I would ask if that was the same guy who bought puts before.)

If enough people cash in their shorts, you get a rally. Here's the problem: Unless it is in puts, you don't know if the buy is an outright buy or a buy to cover.

(You don't know if someone is establishing a new long position or just buying back something that he sold higher earlier.)

For example, someone short Intel doesn't have to declare, "Buy me 50,000 Intel to cover a short." All he has to say is, "Buy me 50,000 Intel."

(That's about all you'll ever find out unless you are into bragging, and traders aren't into bragging because it is bad luck.)

So you never really know whether anything but put-selling is short-covering. That's why any sort of analysis that says, "20% of the buying today was short covering" is simply impossible to figure out and anyone who says it is just blowing smoke.

(People still try to hazard some figure, but you can't.)

You can only venture a guess away from put sales. That said, I have made it my career to try to divine this stuff because I strongly believe that short-covering is a highly emotional business that involves wildly overpaying short term in order to take the pain away. All day Thursday I detected people trying to buy at all costs. That's usually short-covering. I would rate this rally in particular as buying by motivated short-sellers anxious to preserve their good years vs. the averages.

(Some things are learned by experience. A short gone awry is much more painful than a long gone awry. The reason for that is simple: Your investors presume at all times that you are long. If you tell them on a big up day that you lost them money because they are short, they are very intolerant of that. So if you came in short Thursday and the market took off big, you can bet that some of your investors are going to call and ask you how you did. When you say, "Well, we were short the QQQs and got hurt," you know that they are going to be very unhappy.)

Is a short-covering rally sustainable? Absolutely not.

(Once the shorts have covered, many of the potential longs are no longer interested in where the stocks are. Others recognize that the shorts are like quicksand. They look like real buyers, but once they are through, they don't go long for the most part. So there is a vacuum down, as we saw the following Friday.)

One of the most annoying things about Thursday's rally is that it took a lot of stocks right back to where the shorts will be out there pressing them down again.

(Sure enough, there were some great shorts to be put on in the telecom equipment world after the spike. After Tellabs (TLAB) and Sycamore (SCMR) blew up that group resumed its miserable and understandable downtrend.)

They "lay" on stocks and make them seem heavy.

(Here is a constant gambit of the shorts, to disillusion the longs.)

You see them when you go take an offering of a stock and the offering comes right back at the same price. That's just plain debilitating.

(So, you go to buy 200,000 Cisco (CSCO) at $14.25. You lift all of the offerings. After they are taken, the sellers come back at the same price, even though you might have been willing to pay higher. That's the debilitating, break-the-back posture that the shorts use. It's a brilliant tactic and it always beleaguers the congenitally optimistic longs.)

Shorts aren't going to be deterred from shorting until they feel that there are real "bids" underneath stocks, and not just other shorts covering.

(You have to understand the different ways to buy stocks to get this paragraph. You might want to "take" stock, which means going and buying what is offered, or on the offered side. Or you may "bid" and get hit, meaning you sit on the bid side and you wait for sellers. The momentum funds never show any trading discipline. I don't think they have any. They are all about taking stock and taking it recklessly. I am from the school that buys down and buys unexcitedly, on the bid side. I like to bid and get whacked at "my prices.")

They aren't going to be deterred because ever since we peaked last year that's been the best way to play it.

(Looks like they did it again. As soon as the bears had brought stuff in, the moron longs who are down huge came in to buy their favorite stocks to average down and to keep the rally going. I can't believe there are still funds around that do this, but there are. Bunch of stooges.)

Sometimes you have to wait a day or two before you start putting the stocks out again. Sometimes, the rallies are so short and sharp that you have to put them out on the same day as the big spike.

(That was the case with the networkers and telcos, which have no real reason to be bought here given that the earnings estimates are still going down.)

I think that the possibility of a perfect-world-for-the-bulls unemployment number made the shorts more eager to cover than they would normally have been. I am confident that if we get a rally, the shorts will be all over their targeted names by midafternoon.

(We got that rally, and then we got an employment number that some would view as confusing, but I would view as clear-cut in favor of an immediate ease.)

Why isn't it more sustainable? Because when you have such a sharp swift rally you don't get good, long-term buyers, you just get short-coverers.

(Short-coverers typically buy to sell again, usually a few points above where they purchased. They are very smart about trading around positions.)

The kinds of buyers we want aren't "pay up" buyers who think they can buy up two to sell up three. The kinds of buyers we want if we want to believe in a long-term rally are "bid side" buyers, firms that get hit trying to buy merchandise and then stand there and buy more and more and more. This kind of move is totally unsustainable.

(We want people who say, "I will buy a stock on the way down because it is getting cheaper," not people who say, "Wow, that chart just got nasty, sayonara.")

What would we have liked to see if we are going to get out of this morass? Here's a way to look at it: You would have liked to have seen this same rally, same exact rally, unfold over days, maybe weeks even, so that the people who got in aren't fast-money types and we didn't get short-covering because the shorts didn't panic. That's a sustainable rally. That's what we want. That would have been a thing of beauty for the longs.

(I long for a gentle gathering upward instead of the jerky spikes we've had all year.)

Instead, we got this force-fed, steroidal rally that can't last. Now, of course, for a trade, we want to take what we can get if we are long. But if you were to ask me about the "significance" of Thursday, I would have to tell you that the only thing Thursday accomplished was to cause the shorts to be a wee bit less cocky.

(That's the takeaway from Friday, too. The shorts came right back when the averages faltered and only the curbs kept the market from tumbling.)

Maybe, after two or three times of that, the shorts will no longer be so bold and we will start to have the bear capitulation that hasn't even started yet. Heck, we still have bulls capitulating! However, the only way that will happen is if more companies back up when Dell and BEA Systems did, telling you things are on plan. Right now that's not the case. That's what we will have to be looking for.

(In other words, Dell and BEAS don't a trend make, or, if they did, it was broken by Sycamore.)

Right now call me skeptical, but positive. Too late to sell, but still OK to do some buying.

(Again, that has been my posture since 1800 on the Nasdaq and I am not varying it. I prefer the Dow and bought a lot of old-line companies last week into the weakness.)

James J. Cramer is a director and co-founder of He contributes daily market commentary for's sites and serves as an adviser to the company's CEO. Outside contributing columnists for and, including Cramer, may, from time to time, write about stocks in which they have a position. In such cases, appropriate disclosure is made. While he cannot provide personalized investment advice or recommendations, he invites you to send comments on his column to