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Predatory Trading and Crowded Exits: New thinking on market volatility by James Clunie

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Chapter 3. Crowded Exits

Consider the following situation. You are a short-seller and have identified a highly leveraged firm that is exposed to the general health of the economy. The firm has pared down costs in the past few years (and so has limited potential for further efficiencies). Management is well regarded and the high stock price reflects their achievements to date. But now the economy is starting to slow…

The stock price begins to fall from its peak and you anticipate that this could be the start of a trend. You short the stock. The stock continues to fall and your short position moves into profit. You sell more. Other short-sellers begin to notice the same opportunity and short-interest rises.

The stock price is now falling precipitately ...

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