Although short selling -- the practice of selling borrowed shares with the hope of repaying the loan by buying back the shares at a lower price -- goes against the American belief that stocks always go up, I have long been fascinated with it. Short Stories discusses what works, what doesn't, and what some of the leading lights in shorting stocks think about its opportunities and threats. I describe possible short trades and seek your comments and questions for story ideas. I don't offer any investment advice and I don't trade on any of the posts I write.

Last night Bloomberg News reported that American Home Mortgage Investment Corp (NYSE: AHM), which catered to borrowers with good credit, would file for bankruptcy -- possibly August 6th -- a few days after it shut down most of its operations. This week American Home stopped making loans and fired 90% of its 7,000 employees after a surge in borrower defaults prompted investment banks to quit extending credit.

This suggests that NovaStar Financial (NYSE: NFI) which I suggested shorting last December at a split-adjusted price of $116 could soon follow suit. That's because on Friday, according to Reuters, NovaStar -- which specializes in subprime mortgages -- announced to brokers that it would stop funding certain mortgages "temporarily." This is a less extreme version of what American Home did earlier this week.

So despite receiving a $150 million equity infusion last month, NovaStar's bankers may decide not to throw more good money after bad and pull its credit just as American Home's bankers did.

If NovaStar does file for bankruptcy, it will make itself into an object lesson in how to short a stock successfully. The basic lesson is to look for a company that owes more money than it can pay back. In NovaStar's case that looked like a good bet last December.

If an acquirer steps in at Friday's after-hours price of $5.74, then the short position -- though up 1,921% -- will be a bit less valuable than if NovaStar files for bankruptcy.

Update: This morning's Kansas City Star reports that Friedman Billings Ramsey analyst Scott Valentin cut his target price for NovaStar to zero -- it is currently trading at $4.39. So if you covered a short position initiated last December, you could realize a 2,542% return on your investment.

Peter Cohan is President of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in American Home or NovaStar.