It was late October 2008, and we were in the midst of one of the worst bear markets of all time.
Short-biased traders were making a killing, but most of us bulls were getting hit daily. As a professional proprietary trader, my software constantly scanned the world's markets for unusual -- and thus potentially profitable -- moves in stocks.
I was alerted to a company that I never paid much attention to: Volkswagen. Within two days, the stock price increased by more than 180%, making Volkswagen, for a short time, the most valuable company on Earth.
Short sellers reportedly lost more than $35 billion during those two days. As the share price climbed, short sellers were forced to cover their positions -- making the stock shoot up even higher.
I was witnessing my first short squeeze -- the greatest in history, as it turned out. Many nimble investors turned massive profits during this time.
My lesson? Keeping track of short interest in a stock is a valuable metric for stock investors.
What Is A Short Squeeze?
One of the biggest worries of short sellers is the dreaded short squeeze. But finding short squeeze candidates can be a lucrative tactic for investors.
A short squeeze occurs when a stock is widely shorted and unexpected positive news or other factors lift the price. Frightened by the potential of a greater loss, short sellers dump their short positions. That results in buying pressure, forcing shares even higher. Then additional short sellers are forced to close their positions by buying back the stock. That causes shares to rocket.
How To Find Short Squeeze Candidates
One of the easiest ways to locate short squeeze candidates is to check short interest at StreetAuthority's Yahoo Finance page. The higher the short ratio, the more likely the stock will experience a short squeeze rally.
I have identified three companies with increasing short interest that could lead to a short squeeze rally.
| This once high-flying tech stock has been beaten down to below $400 this month. Falling from a high of a little more than $700, Apple (AAPL) has plunged nearly 50% in seven months. |
Citing weakening demand, analysts have slashed their outlook for the tech giant in recent months. Apple is largely a victim of its own success, as investors hold the company to ridiculously high standards of performance. Even with record-breaking sales, analysts expect more -- and that hurts the stock price.
Recently, Goldman Sachs (GS) removed Apple from its conviction buy list. To make matters worse, Apple's new spaceship-style headquarters will cost an estimated $2 billion more than was spent in 2012 on research and development. Add the growing threat from competitors such as Samsung (SSNLF), and it's unclear whether Apple's stock can return to its former heights.
As you can imagine, short sellers have piled into Apple's decline. Short interest has doubled since the same time last year. Shares short stand at about 20 million, which isn't much when compared with the 940 million outstanding shares. However, as short interest increases, the chance for a short squeeze grows. Buying on a breakout above $400 makes sense with a $450 12-month target.
In technical analysis, round numbers such as $400 or double zeros are considered to be psychological resistance or support.
| A leader in the struggling solar industry, First Solar (FSLR) posted dismal fourth-quarter earnings and guidance. |
Short interest has fallen from more than 30 million shares short in July 2012 to just above 18 million in March, but it has increased since mid-February. There are only 87 million shares outstanding with a float of 60 million, making 18 million shares short a significant number. Even a tiny amount of good news may launch a short-squeeze rally in this alternative energy name.
Technically, shares have climbed since April 8. The stock is above the 50- and 200-day simple moving averages.
I like First Solar as a breakout buy candidate above $40 with a 12-month target of $50.
| Formally known as Research in Motion, BlackBerry's (BBRY) short interest has been climbing steadily since April 2012, tripling to more than 155 million shares. This equals 30% of the outstanding shares. This increase comes despite the latest numbers revealing revenues at just under $2.7 billion with a profit of 22 cents a share. |
Most interestingly for the bulls, the company's cash balance remained steady at just under $3 billion, providing BlackBerry a potential lifeline.
Of the three stocks, I like this company the most due to its substantial number of shares short, which will likely trigger a short squeeze on any additional bullish news. Technically, support in the $13 range makes this stock a prime candidate for a breakout trade above $15. I wouldn't be surprised to see this stock at $20 within the next 18 months.
Risks to Consider: It's important to remember that although a company may face high odds for a short-squeeze rally, one isn't guaranteed to occur. In addition, all three of these companies have substantial headwinds to battle.
Action to Take --> I like all three of these stocks as potential breakout buy candidates. However, remember to wait for the upward momentum before entering a position.
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