Here are principles from Dana Glante from the Stock Market Wizards book by Jack Schwager on how she made double digit returns year after year from her short only trading strategies even in bull markets. Steve Watson in the same book contributed the last one.

10 RED FLAGS:

  1. High receivables (large outstanding billings for goods and services).
  2. Change of accountants.
  3. High turnover in chief financial officers.
  4. A company blaming short sellers for their stock’s decline.
  5. A company completely changing their core business to take advantage of a prevailing hot trend.
  6. A VERY high P/E ratio
  7. A catalyst that will make a stock vulnerable over the near term.
  8. An up trend that has stalled or reversed.
  9. Stocks breaking below their 50 day moving average.
  10. A high priced one product company with low barriers for competitors to enter and compete.

In addition I would also say to cap the unlimited risk to the up side by using long put options instead of out right selling the stock short as long as options have enough liquidity for a tight bid/ask spread. Former leading stocks that have disappointed make the best short plays they have the most potential down side.