Hedge Funds Deepen Short Positions in Software Sector, Pocketing $24 Billion in 2026

Hedge funds are widening their bearish stance on publicly traded software companies, accelerating a sell-off that has erased more than $1 trillion in market value since January. Data compiled by S3 Partners show that short sellers have realized approximately $24 billion in mark-to-market profits this year, and portfolio managers at two large Wall Street funds say additional positions are being opened as prices continue to weaken.

The shift comes amid a broad retreat in technology shares. The iShares Expanded Tech-Software ETF (ticker IGV), a benchmark for the U.S. software industry, fell 8 percent this week and is off more than 21 percent for the year. From a record high reached in September 2025, the fund is now lower by roughly 30 percent. Market participants attribute the sharp reversal to concerns that artificial-intelligence applications could replicate or commoditize basic automation tools offered by many legacy vendors, reducing long-term revenue visibility across the sector.

How the trades are structured

Short sellers borrow shares through a broker, sell them on the open market, and later repurchase the same quantity, ideally at a lower price, to return to the lender. The difference represents the profit or loss on the trade. The strategy is legal but subject to regulations under Rule 204 of the U.S. Securities and Exchange Commission, which requires timely delivery of borrowed shares.

S3 Partners’ data indicate that the most heavily shorted names inside IGV are companies with business models perceived as easily replaceable. TeraWulf, a provider of energy-intensive computing infrastructure, currently has short interest exceeding 35 percent of shares available for trading. Workflow manager Asana posts a 25 percent ratio, while cloud-storage firm Dropbox and blockchain miner Cipher Mining stand at 19 percent and 17 percent, respectively.

Sector-wide declines

Price pressure is not confined to smaller or specialized firms. Large-capitalization constituents such as Microsoft and Oracle have fallen 15 percent and 21 percent, respectively, since the start of 2026. Salesforce, Adobe and ServiceNow each show declines above 20 percent. Mid-cap software providers Intuit, known for its tax-preparation products, and DocuSign, a digital document-management platform, have dropped more than 30 percent.

One senior analyst at DA Davidson notes that the collective hedge-fund positioning is now net short across the software landscape, a reversal from the overweight exposure observed through most of 2025. The analyst adds that funds often build larger stakes in securities experiencing heavy, indiscriminate selling because lower liquidity can magnify downside momentum.

Credit conditions remain stable

Despite equity weakness, a banker who arranges credit facilities for technology companies says there is limited stress in loan covenants or revolving credit lines. Most borrowers have yet to draw down their committed facilities, suggesting that liquidity remains adequate and that lenders are not demanding restructuring discussions at this stage.

Some market strategists argue that the decline in valuations could spur merger or acquisition proposals from cash-rich industry leaders or private-equity sponsors seeking bargains. While no deals have been announced, bankers report a modest uptick in exploratory conversations, particularly around companies trading at multi-year low revenue multiples.

Upcoming catalysts

Investor sentiment may face an immediate test as several software firms prepare to release quarterly results over the next two weeks. Earnings guidance will be scrutinized for signs that generative-AI competition is eroding renewal rates or pricing power, issues frequently cited in recent research notes.

Imagem: Internet

Options markets imply elevated volatility around those reports, indicating that traders expect wide post-earnings price swings. If corporate outlooks improve relative to lowered expectations, some of the outstanding short interest could be covered, potentially triggering a short squeeze. Conversely, weaker-than-forecast bookings or margins could reinforce the prevailing downtrend.

Why hedge funds are staying aggressive

Portfolio managers familiar with current positioning describe three primary reasons for maintaining or expanding short exposure:

• Revenue uncertainty: Clients experimenting with low-cost AI solutions may delay or cancel contracts for conventional automation software, undermining sales pipelines.
• Valuation compression: Even after the pullback, many software firms trade at revenue multiples above historical averages, leaving room for further downside if growth decelerates.
• Technical momentum: Lower lows in sector-wide charts entice systematic funds to increase short weights in trend-following strategies.

While fundamental investors often seek to identify long-term value in cyclical downturns, short-biased funds emphasize near-term catalysts. One portfolio manager highlights that software cost structures are heavily weighted toward research and development and sales expenses, limiting immediate margin flexibility. Rising interest rates compound the challenge by increasing the discount rate applied to future cash flows, making current earnings growth more critical to valuation.

Market impact and potential risks

The $24 billion in unrealized and realized gains logged by short sellers represents one of the most profitable sector-specific bets of 2026 to date. However, the strategy carries risks. Should earnings prove resilient or if central banks signal a shift toward more accommodative policy, software shares could rebound sharply, eroding paper profits. Additionally, any unexpected acquisition announcements could force rapid short covering in individual names, causing price gaps that are expensive to hedge.

For now, trading desks report that borrow availability remains adequate for most liquid software stocks, keeping execution costs contained. Nonetheless, specialists caution that borrow rates can rise quickly if demand intensifies or if long holders withdraw shares from lending programs.

With volatility elevated and sentiment fragile, both long-only and alternative managers are preparing for sizable price moves in the coming weeks. The next round of earnings may determine whether the software sector stabilizes or whether hedge funds add to what has already become one of the most aggressive short campaigns since the early-2020 pandemic-era technology correction.

Crédito da imagem: Brendan McDermid/Reuters