What causes stocks to have Supernova spikes?
You know, moves so unprecedented, that they defy logic and reasoning.
I’m not kidding.
Crazy stuff happens all the time… like when market forces pushed Volkswagen to become the largest company in the World (for one single day in 2008)…
(for a single day, VW had a larger market cap than Microsoft, Apple, and Exxon!)
But you don’t have to go back a decade for other cases similar to this. In fact, they happen all the time… and they are called short squeezes.
What are they about? How can you find them?
You’ve probably seen a stock just explode higher… and continue to run up with no end in sight. Well, that’s what we call a short squeeze.
If you can spot potential short squeezes… it can be very lucrative.
Before you start buying stocks poised for a short squeeze… you need to understand the mechanics behind a short squeeze and what causes them.
Now, traders must borrow shares in order to short (bet against) a stock. You see, they’re trying to sell something they don’t own and in order to do that… they need to borrow shares from someone who is long the stock (usually you would just borrow shares through your broker).
However, at some point, they’ll need to cover their shares to “return” them to the rightful owner.
What causes short squeezes?
Well, first there is a high number of shares short. In other words, there are a lot of traders betting against the stock and the reasons for that can range from a bearish chart pattern to weak fundamentals.
Now, there are a few key statistics that traders look for: short float and short interest ratio. Basically, the short float is the total number of shares short as a percentage of the floating shares (the shares available to trade).
You can find this data from sites like Finviz and Morningstar.
On the other hand, the short interest ratio is the total shares short divided by the average daily trading volume.
When both the short float and short interest ratio are very high, that means a stock is prime for a short squeeze. Now, what’s considered a high short float? Well, generally, 10% is considered high. While a short interest ratio above 5 may be considered high.
What Causes Short Squeezes
Now, if a heavily-shorted stock releases bullish news or breaks above a key technical level, and runs higher… shorts may be forced to cover.
Think about it like this… when a stock goes up, shorts lose money… so if there’s extremely positive news the shorts actually have to buy back their shares. In turn, this actually increases the demand for the stock.
When there’s a high short float followed by a move higher… there’s actually less supply. In other words, there are not has many people that can short the stock, causing it to become hard to borrow.
What happens when there are low supply and heavy demand?
Well, the stock goes up.
Now, if the stock continues higher… more shorts are forced to cover, which sends the stock even higher… and becomes a vicious cycle for the bears.
For example, here’s a look at some statistics on Overstock.com (OSTK) from Finviz.
If you look at the chart in OSTK, it’s been beaten down… and that means there are a lot of shares short. If you look at the shares float (Shs Float) it’s at 56.18%. That means over 50% of the shares available to trade are short.
Additionally, OSTK has a short ratio of 4.53.
Remember from earlier… what typically sparks a short squeeze is a break above a key level or positive news.
Well, OSTK actually had a lot of positive news. First, there was the epic bounce in Bitcoin… which caused blockchain- and crypto-related stocks to follow suit. Thereafter, the company actually announced a series of bullish news.
The CEO hinted at a potential deal with its retail business, as two acquirers have approached the company. Not only that, the CEO had some positive comments about its Blockchain business. Moreover, OSTK finally launched its tZERO Crypto Wallet Mobile App.
Here’s a look at the daily chart in OSTK.
Now, the first move was caused by the move in cryptos and breaks above key levels. First, we saw Bitcoin run higher… then OTSK broke above $10 and a key moving average. That caused some short covering.
Thereafter, with more positive news, OSTK broke above the 50-day simple moving average (SMA)… more shorts covered.
You get the idea.
With positive news and breakouts of key technical levels, OSTK is up more than 100% since early June.
Now, we actually see this a lot in the market, especially with penny stocks. Typically traders bet against penny stocks… thinking they’ll go bankrupt because they’re not in a good financial position. That leads to a high short float and a potential short squeeze.
The other day, I actually spotted a short squeeze play based on a technical breakout. The stock had around 10% short… and it was prime for a short squeeze.
I was looking for a break above the blue horizontal line… and with a relatively high short float… if it broke above that level… the stock could’ve continued much higher. Now, I was actually able to lock in around ~$300 (around 15% on the trade) in just 10 minutes… and you can read more about the trade here.
As you can see, understanding the mechanics behind and what causes short squeezes can uncover more trading opportunities for you. If you’re looking to learn more about trading and want to build your trading account up fast, then check out my latest video training lesson here.
If you’re ready to take the next step… then click below.