Brewer, Could you comment on the rationale for heavily shorted stocks trading in an inefficient market? Just off the top of my head, if by heavily shorted you mean stocks with a relatively large fraction of float shorted, then I can't figure what a reason might be. Some of the most thorough researchers around are the shorts. Maybe if you are including stocks which are subject to some sort of arbitrage against another security?
No, I am not talking about arbitrage shorts. I am talking about large, plain old short positions that amount to a big chunk of the float and prerably many days to cover. I currently have one of my largest positions in the company with the highest days to cover on the NYSE as of the August reporting date (PPD, with over 140 days to cover). Some of the biggest killings I have ever made (PLMD, CTAC, MINI, with NLS, MOVI and PPD in the process) have come courtesy of the shorts. I tend to treat the top 10 days to cover lists as a shopping list, or at least a prospects list.
You would think that the shorts would A) do their research and B) have the sense to take profits when they get the chance. However, time and time again, I see big short positions maintained in (especially smaller) companies long after the issues that attracted the shorts have been nullified or dealt with. Take PLMD, for example. The are a Medicare beficiary supplier of diabetic testing supplies (surely you have seen the Wilford Brimley cable TV ads) and they came under investigation for Medicare fraud via a qui tam suit. It was pretty clear to me that this was a minor issue at most, but the stock plunged, especially when some of the more unscrupulous short mouthpieces began bashing the company in public (Manuel Asensio, Herb Greenberg, et al.). I bought a truckload. Long after it was apparent that the Feds were not going to shut the company down (haven't even fined them yet years later) the short position was maintained and even increased. Guess what? My basis is about 1/3 the current price and PLMD now pays nice dividends.
Everyone says that the shorts have the best reserch on Wall St. I certainly cannot agree, at least not in all cases. They also don't seem to have adequate risk controls in place to get out of a short squeeze. PPD is staring down the barrel of a tender offer that I think is aimed at rectifying the excessive short position. NLS has been performing beautifully of late and the shorts are trying to get out. MINI appears to have one big hedge fund (pennant) trapped as the fund has a big shoprt position in the stock but couldn't hope to buy it all back without rocketing the share price upwards. MOVI is spewing out cash to beat the band and could go private tomorrow at a nice premium to market. Do these sound like situations in which you'd like to be short? Not me.