Advertisement
U.S. markets open in 4 hours 33 minutes
  • S&P Futures

    5,306.00
    -2.25 (-0.04%)
     
  • Dow Futures

    40,153.00
    +9.00 (+0.02%)
     
  • Nasdaq Futures

    18,492.75
    -11.00 (-0.06%)
     
  • Russell 2000 Futures

    2,134.60
    -3.80 (-0.18%)
     
  • Crude Oil

    81.67
    +0.32 (+0.39%)
     
  • Gold

    2,195.90
    +5.30 (+0.24%)
     
  • Silver

    24.57
    -0.19 (-0.76%)
     
  • EUR/USD

    1.0793
    -0.0036 (-0.33%)
     
  • 10-Yr Bond

    4.1960
    0.0000 (0.00%)
     
  • Vix

    12.95
    +0.17 (+1.33%)
     
  • GBP/USD

    1.2606
    -0.0032 (-0.25%)
     
  • USD/JPY

    151.4080
    +0.1620 (+0.11%)
     
  • Bitcoin USD

    70,607.71
    +956.04 (+1.37%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • FTSE 100

    7,958.18
    +26.20 (+0.33%)
     
  • Nikkei 225

    40,168.07
    -594.66 (-1.46%)
     

Squeezing the Market: Riding the Rollercoaster of Short Squeeze Mania

On Wall Street, short selling (borrowing shares to bet against a company) is one of the most challenging endeavors to master. First, from a long-term perspective, anyone shorting is hypothetically swimming upstream. Why? Because U.S. markets tend to march higher over the long term.

Zacks Investment Research
Zacks Investment Research


Image Source: Zacks Investment Research

Pictured: Over time, stocks go up.

Second, even in down markets, short-covering rallies can be vicious. For example, in April 2022, after the initial downside break, the Nasdaq 100 ETF (QQQ) rallied 10% in just two weeks before cracking wide open.  In other words, ill-timed short sellers would have been blown out of their positions.

Zacks Investment Research
Zacks Investment Research


Image Source: Zacks Investment Research

Pictured: Shorting is easier in theory than practice.

Finally, investors theoretically face unlimited risk in short selling whereas unleveraged long positions face no more than 100% downside.

Short Squeeze Mania

2022 was a rare year where short sellers won. Former high-flying names such as those in the ARK Innovation ETF (ARKK) got hammered as sellers came after high-valuation growth stocks. However, markets act in a cyclical manner.  As the market finds a bottom, beaten-down stocks stretch to the downside, and late short sellers pile in, short squeeze opportunities develop.

In late 2021, Carvana (CVNA) traded as high as $376 per share. However, as car sales slowed, the eCommerce company’s economics declined, and Carvana swung to a wide loss.

Zacks Investment Research
Zacks Investment Research


Image Source: Zacks Investment Research

By late 2022 shares were trading as low as $3.55, down 98% from its highs.

Zacks Investment Research
Zacks Investment Research


Image Source: Zacks Investment Research

Nonetheless, the online auto-retailer provided a perfect example of a short squeeze phenomenon on Thursday. The beaten-down stock price, a short interest north of 50% of the stock’s float, and positive news fueled the fire. Thursday, the company surprised Wall Street by divulging that it expects to swing to a profit of $50 million. The unexpected news sent shorts running for the hills and the stock higher by 56% on the session.

Zacks Investment Research
Zacks Investment Research


Image Source: Zacks Investment Research

A Domino Effect

Ever since the Reddit forum “Wall Street Bets” sent shares of GameStop (GME) into the stratosphere in 2020, one lesson investors have learned is that a few times a year, when market speculation runs high short squeezes spread like wildfire. For example, in 2020, the GME speculation spread to stocks like Virgin Galactic (SPCE)AMC Entertainment (AMC), and Palantir (PLTR). The CVNA squeeze spread to other beaten-down and heavily shorted names like Beyond Meat (BYND) Thursday.

Catching a Short Squeeze

The secret sauce for catching a short squeeze is to look for:

·       Heavily beaten-down names crossing over the 200-day moving average.

·       Highly shorted names (20% or more of the float should be short)

·       Ensure that you’re in a speculative market (major indices and high-flying stocks are in play)

It’s a Matter of When, Not If, the Music Will Stop

Because of the inherent volatility and overnight gap risk associated with heavily shorted stocks, short squeeze plays should be traded with minimal size or not at all. History teaches us that when the “trash floats to the top” like it is now, it is typically short-lived and ends badly. In other words, if you’re going to trade highly shorted names sell some into strength and date them, don’t marry them.

A swath of short squeezes can be a sign that the market is becoming frothy and danger (or at least digestion) is ahead. For example, Virgin Galactic shot from $14 to $57 in two months, just before the tech space began to break down.

Zacks Investment Research
Zacks Investment Research


Image Source: Zacks Investment Research

Takeaway

Thursday saw a swath of short squeezes in the market. Investors who want to participate in trading heavily shorted stocks should consider the implications ahead of time. Regardless, short squeezes can signify short-term frothiness in equities markets.

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

GameStop Corp. (GME) : Free Stock Analysis Report

Invesco QQQ (QQQ): ETF Research Reports

AMC Entertainment Holdings, Inc. (AMC) : Free Stock Analysis Report

ARK Innovation ETF (ARKK): ETF Research Reports

Carvana Co. (CVNA) : Free Stock Analysis Report

Beyond Meat, Inc. (BYND) : Free Stock Analysis Report

Virgin Galactic Holdings, Inc. (SPCE) : Free Stock Analysis Report

Palantir Technologies Inc. (PLTR) : Free Stock Analysis Report

To read this article on Zacks.com click here.

Zacks Investment Research

Advertisement