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

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

I paper-traded a setup in Baidu.com, Inc. (ADR) (NASDAQ: BIDU) today, since I was out of daytrades.

I was watching the markets near 12:00 , when I saw that the QQQQ’s were smacking into $50 on low volume. I thought it would fail (and it later did). This gave me a short bias, and I noticed that BIDU was breaking below an inter-day pivot point on this 15′ chart:

I also noticed that my HMA/EMA crossover trend indicator was bearish. I would have gone short at the orange line, and the stop would have been at the red line at $213.04 (picked off of the 1′ chart swings). The initial target would have been the $210 level, all as I said on Wallstreak. In the end, with the partialing out, it would have been good for about 2.5R profit, though it was hairy in the first few minutes, moving to about -0.7R at one point!

More things to notice are pointed out in this 5′ chart:

The volume on the down moves was advancing, while the volume on the up moves was declining. This relationship between price direction and volume trend is a key to determining if an adverse move is simply a retrace or is actually a reversal. In general, retraces will come on declining, below average volume, and will be in the 38%-50% retracement range. Reversals happen when the character of the price/volume relationship changes–a volume spike that reflects capitulation buying / selling, a change to higher volume on adverse moves, etc. Note that if you covered the remainder of the position at the volume spike into the pivot point support at about $208, you would have covered right near the best price of the day, even if you waited until the close! Volume spikes like this are important points, where people who are forced to exit puke out their position at any cost. You want to be there to unwind your position through them, whether covering your short with their panic-sold shares, or offering your shares to a freshly-squeezed short seller. You’re actually doing them a service, since if your liquidity was not there, they would have to take a worse price to exit.

My strategy is to enter at inflection points, where a consolidation is broken and a new move gets underway. I want to exit profitably into strong price moves in my direction on high volume, when people who are trapped and wrong rush to the exits. This is how institutions operate, though not as nimbly as a small-time daytrader can; their accumulations and distributions can take weeks or months. I have to give a huge shout out to Jamie, as he has taught me so much about this trading style through his blog. The Tape Reading book I bought has also been immensely helpful, and I recommend it.

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