Squeeze the Shorts!

This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com

The most profitable time to exit a position is when other people who are wrongly positioned in the opposite direction are forced to liquidate theirs at any price. That’s when you get the most violent price action and major capitulation. When you have a heavily shorted stock, it can be ripe for a short squeeze, where price runs up hard and fast, causing people with short positions to rush to buy-to-close their position. While the markets environment of late is not really conducive to short squeezes, if the bull returns the environment will be ripe again. With all the bearishness as of late, there are probably a lot of fresh short positions that might pay off in the event of a reversal.

One key to this is if the amount of shares sold short is large compared to the float (shares not being held by insiders and institutions that are immediately available to buy or sell). An example taken from http://finance.yahoo.com/q/ks?s=LNN:

You see that the float of LNN was 9.48M and the number of shares sold short was 2.45M, or 22.6% of the float. Having a large amount shares sold short compared to the amount of float is like having way too many people packed in a small movie theater. If somebody (metaphorically speaking) yells “fire”, there will be a rush for the exits, and it will take a long time for all the panicked people to get out. In the markets, if some news or other event yells “fire” (buy!), the price will rise, and the huge ratio of shares sold short to float available exacerbates the problem, taking the price through the roof. Good for you if you are positioned long! In addition, if the average daily volume is low compared to the short positions, then effectively the door to the theater is very small, and the theater will not empty without somebody getting squashed. That’s the idea behind trying to go long in the event of a short squeeze.

How do I catch a short squeeze?

How do you catch a short squeeze play? Well, you have to know a stock that is heavily shorted, with a lot of the float sold short, preferably with an average volume such that it would take many days to cover all of the outstanding shares sold short if people wanted to buy-to-cover at that average volume rate. However, just high short interest and a small “exit door” (small average volume compared to shares short) is not enough. It’s not a squeeze unless the shorts are wrong! If you buy a heavily shorted stock that’s still going down, you’re the one that’s going to get squeezed. You also have to have a catalyst to cause the shorts to run to the exits. Somebody has to yell “fire”!

Witness LNN, a stock that was heavily shorted and released good earnings news (”fire!”), causing a run in the stock. Once it broke out after the earnings announcement, there was no turning back. Buying the breakout would have made you a big fat pile of cash. The Fly was all over this one, and called it before the fact:

That’s the idea.

So how do I find a Squeeze-alicious stock to buy?

I can’t believe that you said Squeeze-alicious! Well, here’s a start for you. The following is a list of stocks with 50% or more of the float sold short as of the latest reporting:

Look for signs of strength in one of these stocks, and if there’s a catalyst that starts a rally, you’ll have more likelihood of getting good follow through to the upside.

Leave a comment if you have any better ideas on how to capitalize on short squeezes, or better ways to identify likely squeeze candidates other than % of float sold short. There’s a lot of different ways to sort the universe of roughly 5000 stocks that you can get data for!

This post was contributed by a guest author, and does not necessarily reflect the views of Richard or MovetheMarkets.com