Solar's Short Squeeze Days Are Numbered

Robert Weinstein

NEW YORK ( TheStreet) -- Tuesday was a blood bath for the First Solar , LDK Solar , Trina Solar , Yingli Green Energy , and Sun Power short sellers. The short seller party was well attended based on the latest short interest numbers.

First Solar and SunPower have eye-popping 36% and 21% of their floats shorted, respectively. When First Solar announced what appeared on the surface to be vastly improving financials, there wasn't time to think. Once the stocks started moving higher, it was shoot first and ask questions later.

For active and on the edge short sellers, it doesn't matter if your short thesis is still intact if your account isn't at the end of the day. I witness this sort of knee-jerk reaction forcing a spike in share price often. You can as well. Just set your stock scanning software to look for stock spikes, and then looks to see how they performed for the next few days. I am including the most similar scenario to First Solar and the results.

I asked Stockfinder, one of the scanning software tools I use daily, to search for stocks with the following attributes:

As should be evident by the simplicity of the criteria, I didn't curve fit for any type of result. After as many years of market observation as I have, the results were anything but surprising. Buying a stock at the closing price -- often much lower than the day's high -- during a massive price spike results in a net annualized loss of over 1000% compared to simply waiting one more day. In other words, after a price spike, stocks tend to retrace quickly.

Stockfinder reports the odds of the next day moving higher is only 43%, compared to a 57% chance the next day will result in a lower closing price. While the odds of higher prices doesn't initially appear terribly atrocious, it's the amount of depreciation experienced when the price does fall that indubitably places price chasers in a world of misery.

If you buy at the close of the spike and hold for a week, the results become even more painful. The winning percentage drops to only 21 percent, and the expected rate of return drops to a negative 2000% (-2125% to be exact).

The odds are against you if you buy at the close, but that doesn't mean there isn't profit opportunity. With the odds stacked up so heavily on one side, it's clear the smart money choice is to short the stock. Short selling stocks isn't for everyone, especially if you don't fully understand the mechanics of shorting. Another method to align the odds in your favor is to buy put options.

While option premiums tend to jump higher during a stock plummet, "melt ups" usually don't cause as much of a spike in volatility. Since options offer a way to exploit a price move lower while capping the potential risk, options can make an excellent entry vehicle into the world of short selling.

To learn more about using options to exploit volatility for profit, get a copy of Options For Volatile Markets by Richard Lehman and Larry McMillan. It's a fantastic book for investors wanting to learn how to manage portfolio risk. Any book by McMillan is a good investment, though. I own a few and give them all high ratings. I wouldn't give such high ratings to the SEC today.

I counted three trading halts while watching the price action of First Solar. Within the solar space, First Solar was the one I paid the closest attention to. I don't see the point in having multiple trading halts for a stock in play.

I get the idea of maybe one halt, but after the first one, the buyers and sellers already know the stock is in a fast market. If you listened carefully, you could almost hear the shorts howling in agony after each circuit breaker trading halt. The final halt I recall was when the price started to fall.

Because a percentage change is used as the basis of a circuit breaker halt, stocks with small prices (under $10) can essentially spend more time halted then trading. I believe the threshold is a 10% move with five minutes.

We already covered the expected peril of buying into a price spike, let's cover what started the spike to begin with. If you haven't read already, First Solar held an analyst day and provided full year 2013 guidance. A few of the numbers released took investors by surprise, especially short sellers.

Revenue in 2013 increased as a result of moving part of the large Desert Sunlight project from 2014 to 2013. Wall Street is a big fan of getting paid today instead of tomorrow.

For tomorrow, actually 2015, investors clearly keyed in on the potential earnings of up to $6 a share. The guidance given is $4-$6 a share, but who is going to remember in 2015, right? You can drive a steamship full of Chinese subsidized solar panels through that figure.

In 2013, analysts have an earnings estimate of $3.46 a share on $3.15 billion in sales. This is where we find the market moving difference. First Solar is reporting guidance of $2.5-$4 earnings a share on $3.5-$4 billion in sales.

After reading the increase in guidance and profit for 2013, you may be tempted to buy into the long thesis and say "this time is different and the price spike is real." But remember, "what the large print gives, the small print takes away".

The difference in 2013 guidance is more a result of moving revenue and profits from 2014 to 2013 than an increase in overall revenue and income. The Street will quickly figure this out, and the time to own First Solar is after, not before.

There is an old saying on Wall Street, "buy when there is blood in the streets." This is equally true for short selling, and we all know the blood is flowing after today.

Disclosure: The author doesn't hold a position in any stock mentioned.

  • Increased at least 35 percent from the opening price
  • Starting price of at least $12
  • Ranked in the top 2500 stocks by volume

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