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It’s one of the most lucrative bets on Wall Street. The pros do it all the time, and yet, not many regular traders are willing to take advantage of it.
I’m talking about profiting from a short squeeze.
Some people think this is one of those trades that only comes with “luck.” But in just a second, I’m going to show you how you can make your own luck by finding stocks that are likely to experience a short squeeze – and the best way you can profit.
How To Find A Short Squeeze Candidate
First, we need to find a stock with a sky-high short interest.
Remember, a trader who is “short” a stock is hoping it will move lower. They do that by selling the stock (without owning it), betting they’ll be able to buy it back at a lower price later. At some point, whether they’re right or wrong, the shares have to be bought to lock-in a profit or cut losses.
If enough traders who were shorting a stock are buying it back, it can cause a “squeeze.”
Think of it this way… If a stock is already going up, it’s because there are more buyers than sellers. But if a stock goes up enough, sooner or later a short seller will have to buy too – either because a stop triggers hit – or their brokers demand they close the position and buy the stock if they’re trading on margin.
Either way, this only adds to the demand for the stock. So the more shorts there are, the better. This is where short interest comes in.
Let’s take a look at the example of my trade in the cybersecurity stock, FireEye (FEYE), to understand this better.
This stock has been a popular target for short sellers for years.
In the case of FEYE, traders were shorting 20.5 million shares of the stock at the time we made this trade. That’s a lot, especially when you consider only 3.6 million shares change hands on any given day. That gave the stock a short interest ratio of 5 – meaning it would take five days of average trading volume for all the short sellers to be able to “cover,” or buy back their shares.
Now, what happens if all these short sellers are wrong? They get burned, that’s what.
If the stock moves higher, then a lot of these traders will start to sweat. And if it moves up enough, they’ll have to buy the stock back – for a loss. This only creates more upward momentum for a stock that’s already moving. And if there’s one thing you’ll notice about traders, it’s that they tend to move in herds. So this can cause a panic among short traders as they all rush to the exits… causing a short squeeze.
How To Profit
Like I said, there’s an easy way to profit from this. In fact, you can make a killing…
In the case of FEYE, I knew that the technical set-up on the charts was good. I also knew that an earnings announcement was right around the corner. Between that and my technique for “spying” on Wall Street insiders, I had a good reason to believe the shorts were going to get burned on this one.
So I bought a call option on the stock just before the stock went soaring. By the end of it all, I made a 324% gain in just a few days.
Now here’s the important thing to remember. That wouldn’t have been possible without options. If I had just bought the stock, I would have been risking a lot more – and I wouldn’t have made as much, either.
But between finding a heavily-shorted stock, “spying” on company insiders, and a little basic technical analysis, I was able to make a low-risk/high upside bet with call options.
I’ll tell you more about my “spying” technique — and the tools I use to analyze charts — in future articles. Keep an eye on your inbox… more to come.
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