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On Tuesday, I told you about short squeezes.
These can happen when too many investors short a stock. “Shorting” is borrowing a share from someone else, selling it, and repurchasing it for less.
And those investors who short a stock pocket the difference.
But if the stock instead starts moving up, people with shorts start losing money fast.
And because they still owe someone shares, they must repurchase the shares. No matter how high the share price goes.
But every short seller who repurchases their shares adds to the demand for the stock. That pushes up share prices even more.
That puts more pressure on other short sellers and can send the share price skyrocketing.
But a bunch of short sellers running for the exits isn’t enough.
To really bid up the price, there needs to be an absolute stampede of short sellers trying to buy shares.
You might remember the 2008 Volkswagen short squeeze I mentioned before. In that one, only 4.8% of Volkswagen’s shares were available.
Porsche had bought up 43% of the company’s stock and controlled another 32% through options. Meanwhile, the German government owned another 20.2% stake.
Altogether, that’s 95.2% of Volkswagen’s shares locked up in the hands of people who would not sell.
No matter how much the short sellers were willing to buy for.
So what you ended up with was not only high demand for shares, as short sellers raced to buy back, but also low supply, as hardly anyone could sell shares to the short sellers.
This low supply is a crucial element in every short squeeze. In finance, we call it high “short interest.”
Short interest is a measure of how much a given stock is being shorted. It’s sometimes given just as a number. For example, 26.83 million shares of Tesla were sold short as of Aug. 13.
Sounds like a lot. No wonder, because for as long as Elon Musk has been hyping his company, investors have been betting against him.
But on its own, that 26.83 million number doesn’t tell you much. Does that account for just a fraction of Tesla shares? Is it most of the shares? Is it even more than 100%?
Remember, knowing the answer is key. Because to know whether a short squeeze is possible, it’s not enough to know that there are short sellers.
We also need to know that few others are willing to sell to the short sellers.
That’s why you might prefer to look at short interest as a ratio.
The short-interest ratio is defined as the number of shares that are being shorted divided by the stock’s average daily trading volume.
So let’s go back to Tesla. 26.83 million shares sold short sounds like a lot. But as of Aug. 13, Tesla’s float was a whopping 801.73 million shares.
That means that Tesla’s short interest ratio was a measly 3.3%.
Way too low to be likely to cause a short squeeze. (At least in this stock. Tesla investors tend to like Elon Musk a whole lot, so they may be less willing to sell than others.)
Now that you know what short interest is, here’s how to use it.
Remember, short squeezes happen in stocks with high short interest that suddenly start moving up in price. That causes panic among short sellers, and they run over each other and bid the price up even more.
Even a tiny short squeeze can give a stock a nice boost.
That’s why high short interest is a bullish signal for a stock. Yes, it means that lots of people are pessimistic about the company.
But it also means that if the stock starts moving up, there may be a short squeeze that moves the price even higher.
There are several ways to find stocks with a high short interest. For example, you can look it up manually on the “Statistics” tab of a stock’s page on Yahoo! Finance.
Some websites specialize in short interest, such as highshortinterest.com or MarketWatch’s Short Interest screener.
As I’m writing this, the seven U.S.-listed stocks with the highest short interest levels, all above 32% of float, are:
- Big 5 Sporting Goods Corp. (BGFV) — 38.42%
- Workhorse Group Inc. (WKHS) — 37.33%
- Blink Charging Co. (BLNK) — 33.95%
- Arcimoto Inc. (FUV) — 33.25%
- SmileDirectClub Inc. (SDC) — 32.74%
- Gogo Inc. (GOGO) — 32.23%
- Intercept Pharmaceuticals Inc. (ICPT) — 32.21%
(data from www.highshortinterest.com)
That list is a good starting point for finding a stock with a catalyst that could move its share price up.
Because with short interest this high, even a small catalyst can set off a larger move. Tomorrow, I want to return to issues around the SEC and another way that Wall Street is costing you money. We’ll tackle dark pools and, yes, they are as ominous as they sound.