Those caught in it, liken it to the feeling of being trapped in a nightmare. You desperately try to wake up but can't. For those of you who experienced it, you know what I'm talking about: The dreaded short squeeze stocks.
How does one possibly avoid the terror of getting caught in this nightmarish stock market scenario? For starters, it helps to know how to identify stocks that are prime candidates for a short squeeze. But first, let's start with the basics.
How to Find Short Squeeze Stocks
- Short squeeze stocks are another way to profit in the market. So how do you find short squeeze stocks? You look look closely at the share counts of a stock calculate the short interest percentage and the short interest ratio. In other words, you look at the number of shares that have been shorted divided by the number of shares outstanding. The good news is, there are websites or tools that do this for you.
1. What Does "Short" Mean?
If you've been our live trading room long enough, you've probably heard traders say, "I'm long in Facebook." Translated into simple language, being long in a stock means you outright bought the shares.
So, 100 shares long in Facebook means you own 100 shares. Nothing more, nothing less. But what does being "short" mean? Instead of owning 100 shares of Facebook, you "borrow them" from your broker and sell them "short" on the open market.
Now, why would one ever want to borrow shares? Based on your extensive technical and fundamental analysis, you think the share price is going to tank.
Your goal is to sell the shares to a buyer at full price now, and hope that the price goes even lower. Essentially, you want to repurchase them at the lower price, return the shares to your broker and keep the profit for yourself.
So, to say "I am short FB," for example, means you have sold shares in Facebook (you don't own), and are hoping their stock price goes even lower. Read our post on how does shorting a stock work.
2. A Real-Life Example of Shorting in Action
For proof, let's look no further than Telsa ($TSLA). In late 2019, investors were betting heavily on TSLA's failure. Unfortunately, the stock price soared by 400% and shorts got hammered. Meaning they got squeezed.
All in they lost close to $8 billion. But that didn't sway them. So much in fact that Telsa was the most-shorted stock in early 2020.
To put this in perspective, more than 18% of outstanding Telsa stock was in short positions! Finally, in March of this year, TSLA fell, along with the rest of the stock market. As a result, short-sellers made close to $50 billion in the sell-off!
3. What Happens to Short Sellers If the Stock Price Rises?
Unfortunately, we are not always right in our stock price predictions. If, for whatever reasons, share prices go up, short-sellers are forced to buy the shares at a higher price. Often quickly. Frantically.
They then have to cough up the difference between the price they shorted at the new price. Our penny stocks list sometimes has stocks to short on it.
What Happens to a Stocks Price After Short Squeeze?
- In the stock market, we always have traders on both sides of the trade, in either long or short positions. A short squeeze happens when stock prices rise to the point that forces sellers to "cover" (repurchase their short position), usually at a loss. The increasing demand attracts more buyers, which pushes the stock price higher, triggering a feedback loop. In turn, this causes even more short-sellers to buy back or cover their positions. And that's what happens to short squeeze stocks and the price. Both bulls and bears essentially push the stock price up together.
"The panic of short cover orders and the resulting increase in stock price is known as a short squeeze." Click here for real time alerts on some stocks that are short squeezing 🙂
1. A Real-Life Example of a Short Squeeze In-Play
As an example, let's say you've been following company ABC and you know they are struggling financially, and bankruptcy news is swirling.
With this tidbit of information, you went short 1000 shares of stock @ $3.00, at a total cost of $3000. However, unannounced to you, they received a financial buyout, which caused the share prices to soar overnight to $4.50.
At this point, you're in the red for $1500. Upon market open, you scramble to buy back as many of the 1000 shares at the lowest price you can.
But you can't get executed. Your blood pressure skyrockets with the rising prices as more and more buyers rush to get in. The endless feedback loop continues as more short's are squeezed and forced to cover.
When it's all said and done, shares skyrocketed to $8.00, and you're on the hook for covering 1000 shares at $8.00. Heart attack imminent at this point.
Now, I'm being dramatic. You likely could have gotten partially filled, but still, to be caught in a short squeeze is not fun.
Welcome to stock market trading.
2. Triggers for a Short Squeeze
- Positive news (i.e. drug trials approved)
- New product announcement
- Beating earning expectations
- A tweet from an influential person
- CEO is on CNBC or another news outlet
- A very oversold condition and a historic level of support is tested
3. Characteristics of Stocks at Risk of a Short Squeeze
Did you know that there are certain characteristics of stocks that make them good candidates for a short squeeze?
A stock that's actively shorted with a high short float and days to cover ratio is ripe for experiencing a short squeeze.
We have two criteria that are useful to identify these stocks: short interest and the short-interest ratio. Short interest is simply the percentage of total shares outstanding that are short. As noted above, Telsa was at 18%, which was extremely high in the trading world. You can check short interest on any stock over at shortsqueeze.com
Alternatively, the short-interest ratio is calculated by dividing the total number of shares short by the stocks average trading volume.
The short interest ratio, also called days-to-cover, refers to the number of days for short sellers to buy back all shares that have been sold short. More often than not, stable companies will have lower short-interest ratios than speculative stocks. We show you high short interest stocks each morning on our trade ideas live screen share.
Is a Short Squeeze Good or Bad?
- Are short squeeze stocks good or bad? The answer to this depends on who you talk to or what side of the trade you are on. There is the side of the coin that feels like shorting is detrimental to the companies the stocks represent as well as the investors of the stock. And then there's the flip side of traders who can see the downturn coming and profit off that move.
1. What Does Short-Interest Tell You?
On the whole, short-interest will tell you if investor sentiment about a company is shifting. We could interpret a decline in short-interest (i.e., less short positions) as a bullish sentiment. Investors think the company is more stable or the price has risen too quickly, and shorts got shaken out.
Alternatively, a short spike interest could indicate bearish sentiment. But, and extremely high short-interested could be a sign of an upcoming short squeeze, consequently forcing the price even higher.
2. Trading the Short Squeezes
As I mentioned above, many "contrarian investors" buy stocks with heave short interest to capitalize on their high-potential short squeeze.
Do I dare compare short-sellers to sharks in the water? Think of the short-sellers as sharks swimming around looking for "blood," or overvalued stocks.
But it isn't without its risks.
There may be good reasons for the high short interest, dismal outlook, lack of investor confidence, the reasons are endless. A heavy short interest doesn't mean the stock price will rise. In fact, many stocks that are heavily shorted keep falling in price.
Which leads me to another huge risk you need to keep in mind: Your unlimited loss potential. For starters, someone who has bought actual stock can only lose 100% of their capital if the stock tanks to $0.00.
However, someone who has shorted stock can lose more than 100% of their original investment if the price skyrockets. Since there is no ceiling for a stock's price, it can rise to the moon and beyond.
However, short squeezes can be the bread and butter for momentum day traders. Many will keep a close eye on these highly shorted stocks and patiently wait for them to rise.
Once the price starts to build momentum, they jump in and buy in hopes of riding the short squeeze wave to the top!
3. Key Reminders About Short Squeeze Stocks
- A short squeeze drives a stock's price up as short-sellers bailout to cut their losses.
- Some traders trade only stocks with a high potential for a short squeeze. To do so, they buy stocks with a substantial short interest.
- Short sales have an expiration date, so be cautious not to be caught having to cover at an undesirable price.
Bottom Line for stocks that short squeeze:
Nothing can guarantee the stock you buy, sell, or go short in will move in the direction you want it to. If that was the case, we'd all be millionaires.
So as to prevent being caught in the short squeeze nightmare, your best bet is to invest in yourself and your education.
Know how to identify the stocks that are setting up and how to read the charts. Know how to enter and exit at the right time.
Invest in yourself, and everything else is easy! An investment in a Bullish Bears membership is the first step in this investment. Make the right one with us today.