We test whether short-sellers in Nasdaq-listed stocks are able to predict future returns based on new SEC-mandated data for the first six months of 2005. There is a tremendous amount of short-term trading strategies involving short-sales during the sample: Short-sales represent 27 percent of Nasdaq share volume while monthly short-interest is about 3.1 percent of shares outstanding (5.5 days to cover). Short-sellers are on average contrarian – they sell short following positive returns. Increasing short-sales predict future negative returns, and the predictive power comes primarily from small trades. A trading strategy based on daily short-selling activity generates significant returns, but incurs costs large enough to wipe out any profits.

Both institutional owners and short sellers decrease their positions prior to earnings announcements, and increase their positions in the post-announcement period. Preannouncement changes in institutional holdings and short interest have significant explanatory power with respect to abnormal earnings announcement returns, where most of the power comes from institutions and short sellers closing positions in order to avoid losses. Analysis of post-announcement returns indicates that aggressive trading by short sellers in reaction to earnings releases enhances immediate price discovery, which reduces their ability to profit from post-earnings announcement drift. The more muted reaction of institutional traders to earnings releases has no significant impact on earnings response coefficients, and allows institutions to successfully target stocks that underreact to earnings news. JEL Classification: G14