Short sellers smelled blood in the water…

In 2008, they had shorted 13% of Volkswagen (VW) shares… betting the stock would tank because it was too expensive. (At the time, VW traded at 19 times earnings—twice that of its competitors.)

Instead, shares soared 379%… in just two days. Short sellers got killed.

On October 26, 2008, Porsche announced that it had bought enough stock and options to control 74% of Volkswagen’s shares. That was good news for Volkswagen…

Another firm, Northern Saxony, held 20% of the company… It wasn’t selling. Passive index funds owned another 6%, and they couldn’t sell shares either.

Combined, they accounted for 100% of VW shares… So as soon as Porsche exercised its options, there would be no shares left for short sellers to buy to cover their positions.

Realizing this, short sellers panicked. They put in bids to buy shares no matter what the price so they could exit the trade.

VW shares soared from 210 euros ($326) to 1,005 ($1,250) over the next two days—a 379% gain. The price eventually fell… but not before short sellers got crushed.

Anyone who sold shares of VW on the way up made a killing.

Not all short squeezes go up that much, that fast. But smaller squeezes happen all the time…

Today, I’ll show you how to find and profit from these short squeezes.

The Short Squeeze

Playing short squeezes is risky—you’re betting against some of the smartest investors in the world. But sometimes even the smart guys are wrong.

Any good news can send heavily shorted stocks a lot higher… And potentially make you some quick gains.

You see, when you short a stock, you’re selling it without owning it. You borrow shares to sell the stock. And then hope the share price drops.

If the price does drop, you pocket the difference between the price at which you sold and the repurchase price.

But if a shorted stock rises too much in price, that can create a short squeeze. A short squeeze is when short sellers start closing out their positions to avoid massive losses. As they buy, they create upward pressure on the stock price.

That’s what happened to speculators who bet against Volkswagen.

I expect more scenarios like this to play out… not as large and drastic as the VW short squeeze… but we could see some 100% moves play out in a couple of months.

The economy is strong… Tax cuts are boosting profitability… And the country is at full employment.

So even a glimmer of good news can send hated stocks higher…

How to Play a Short Squeeze

The first step to finding a potential short-squeeze setup is to look for hated stocks.

You can tell if the market hates a stock by looking at the “short percentage” of its share float. This just shows the percentage of the outstanding shares speculators are shorting.

(To see if a specific company is heavily shorted, I recommend using Yahoo Finance to find the short percentage. When you look up a stock on the website, click the “statistics” tab, then look for “Short % of Float.”)

Generally, a short percentage over 10% means a stock is hated. A lot of smart, big money managers must be betting against it.

Lately, lots of hated companies have popped on good news. For example:

  • Tesla’s (TSLA) short percentage is 31%. Short sellers have lots of reasons to be bearish. But last month, CEO Elon Musk said once again that Tesla was on pace to reach its goal to produce 5,000 cars per month. It doesn’t matter that Musk is unlikely to reach his targets. The stock still jumped 20% in the past month.

  • Rent-A-Center (RCII) had a short percentage of 65%. However, the struggling lease-to-own business for appliances and electronics received a buyout offer from Vintage Capital earlier this month. The stock has soared 57% in two weeks.

  • Video game reseller GameStop (GME) had a short percentage of 43%. On June 19, the company confirmed rumors that it was in buyout talks with private equity firms. The stock zoomed 23% higher in three days as short sellers scrambled to cover their positions.

Again, playing short squeezes is risky. But as you can see, any good news can send a hated stock much higher…

Where to Look

If you want to research heavily short stocks, I recommend checking out MarketBeat’s list of largest short positions.

MarketBeat updates the list about once per month. That’s usually enough updating to find potential short-squeeze setups (short interest usually doesn’t change quickly).

To be clear, I don’t recommend buying a stock just because it has high short interest. That’s a losing strategy in the long run.

However, if you think a hated stock is about to get some good news, you can make a lot of money if you buy before short sellers have to cover their positions.

Regards,

Nick Rokke, CFA
Analyst, The Palm Beach Daily

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