JB Hi-Fi is gapping higher, and brokers will be rushing to adjust their forecasts. It's a recipe for disaster for those caught out with the most shorted stock on the market.

The short positions in JB Hi-Fi are squealing like pigs this morning after the retailer smashed market expectations with its results for the first half of 2013, sending its shares surging more than 10 per cent on the open.

JB Hi-Fi is the most shorted stock in the S&P/ASX 200 index, with 18.43 per cent of its stock on issue in the hands of short sellers. And let me tell you, those shorters wouldn’t be too happy this morning, although I’ve got no sympathy for them at all as they’ve had plenty of warning signs.

I’d love to be a fly on the wall in an office of one of these shorters this morning. There is nothing worse for a hedge fund trader than being aggressively short a stock when it’s gapping higher, like this morning.

Their convictions are being severely tested as we speak; do they try to exit the position and cut their losses or do they stick to their guns and hold the position in the early stages of a bull market?

In my mind, the right thing to do is exit the trade, but that is a lot easier said than done. Trying to buy back a short position in a rising market, and where brokers are likely to be upgrading the stock, is a recipe for a performance disaster.

However, from the perspective of investors or traders holding long positions, it is the ultimate recipe for further gains.

Since the lows of $9.74 less than two weeks ago, the stock is up more than 25 per cent. It will likely attract a lot of attention from the brokers as they frantically scramble to adjust their crystal ball forecasts and recommendations. According to Bloomberg, only 2 of 16 brokers had a buy rating on the stock, which means there is the potential for a huge re-rating of the stock as the brokers and fund managers re-weight into the stock.

It not only beat net profit expectations but it also upgraded its guidance for fiscal 2013 to net profit after tax of between $108 million and $112 million. The market was expecting guidance of $102 million.

At the end of the day, these hedge funds and shorters are basically betting on the end of retailing as we know it. However, as has happened so many times over the decades what appears to be a structural change is actually just the trough of a highly cyclical business.

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