Following the “meme stock” saga of 2021, which saw the likes of GameStop surge 2500% in the space of a month, traders have become obsessed with how to find short squeeze stocks.
In this post, we’ll cover what a short squeeze is, how they happen, as well as the key metrics for identifying potential short squeeze stocks.
We’ll then finish with 2 real-world examples of how to scan for short squeeze stocks using Trade Ideas – which led to subsequent 36% and 50% rallies in just over a month!
What is a Short Squeeze?
A short squeeze is when a heavily shorted stock experiences a buying frenzy, forcing short sellers to cover their losses. This covering exacerbates the initial rally, leading to a sudden spike in the share price.
When you short a stock, you essentially borrow something you don’t own and hope that its value falls. However, since there are no limits to how far a stock can rise, the potential losses on a short position are technically infinite.
Because of this risk, and the implicit liability associated with borrowing shares, your broker requires you to post margin as collateral, which acts like an insurance policy in the case of extreme losses.
How Does a Short Squeeze Happen?
However, problems arise when the share price goes up instead of down – the opposite of what you were hoping. In this case, your broker will ask you to post more margin to cover the mark-to-market (paper) losses on your position, in what’s known as a “margin call”.
If a short seller doesn’t have enough cash to meet this margin call, then their easiest solution is to close out the position by buying back the stock.
As more and more short sellers do this, it creates a self-fulfilling loop of forced buying. In other words, it sets off a chain reaction where buying begets more buying – leading to a parabolic rise in the stock price.
Hence, a short squeeze is when short sellers get “squeezed” out of their positions by relentless buying pressure in the stock market.
How to Identify Short Squeezes
In most cases, buyers target heavily shorted stocks in a predatory manner. They know that if they can inflict enough pain on short sellers, they will eventually capitulate and close out their positions – allowing stockholders to profit from the subsequent rally.
This predatory behaviour is what drove Reddit users to buy the so-called “meme stocks” in 2021, like GameStop and AMC Entertainment.
But how did they know how to spot these short squeeze candidates in advance, you may be wondering?
We’re about to find out…
Short Interest
Short interest is simply the number of shares sold short on a stock. The higher this number is, the more short sellers there are to theoretically “squeeze”. As such, it’s one of the best indicators for finding potential short squeeze stocks.
It can be looked at directly, as a percentage of total shares outstanding, or as a percentage of float.
For example, consider a company with 100 million shares outstanding, a float of 50 million shares, and 5 million shares sold short.
In its simplest, absolute form, this company has a short interest of 5 million shares.
However, while this number provides a useful starting point, it isn’t actually that informative on its own. 5 million shares might be a high short interest for some companies, but a low short interest for others.
How can we tell?
Really, in order to give some context to short interest, we need to look at it as a percentage of the company’s overall share count. There are 2 ways to measure share count: shares outstanding and float.
Percentage of Shares Outstanding
To calculate short interest as a percentage of shares outstanding, you simply divide the short interest by shares outstanding:
SI % Outstanding = Short Interest/Shares Outstanding
This metric tells you what percentage of a company’s total shares have been sold short. In the example above, this would equal 5% (5 million/100 million).
The higher this percentage is, the more would-be buyers there are in the event of a short squeeze. Hence, the easier it is to set off a chain reaction of forced buying.
Percentage of Float
A similar measure is short interest as a percentage of float. The calculation is almost identical, except you divide short interest by float instead of shares outstanding.
SI % Float = Short Interest/Float
Using the earlier example, this would equal 10% (5 million/50 million).
This is a more appropriate measure when a company has lots of closely held shares by insiders. In this case, float gives you a better sense of the number of shares available for trading on a day-to-day basis, and hence the stock’s true liquidity in the event of a short squeeze.
Put another way, the lower the float, the smaller the pool of shares for short sellers to buy back. And, the higher the short interest, the more potential demand there is for those shares when short sellers capitulate.
As such, when a company has a high short interest relative to its float, you have the potential for a severe supply/demand imbalance, and an aggressive share price reaction.
What is a High Short Interest?
There is no simple answer for this, as it is ultimately a matter of opinion. However, in general, a short interest as a percentage of float above 20% is considered high.
Short Interest Ratio (Days to Cover)
The short interest ratio, or days to cover, measures the short interest as a percentage of average daily trading volume (ADTV).
Short Interest Ratio = Short Interest/Average Daily Trading Volume
By comparing the number of shares sold short versus the number of shares typically traded on a given day, we can estimate the number of days required for short sellers to unwind their positions.
The more days it takes, the longer the buying pressure will last in the event of a short squeeze. As such, stocks with high short interest ratios make ideal short squeeze candidates.
What is a High Short Interest Ratio?
Again, this is a matter of opinion. However, generally a short interest ratio above 5 makes short sellers uncomfortable.
This means that if short sellers panic and all head for the exits at the same time, it will take them more than 5 days to cover their positions (assuming average trading volumes).
Social Media Buzz
In recent years, the most well-known short squeezes were born from social media hype. The most prominent being GameStop and AMC Entertainment.
A small group of retail traders worked out that institutions had huge short positions on these stocks, as well as the exact price levels that would trigger margin calls.
All they had to do was convince enough buyers to jump on the bandwagon and push the share price up, thereby squeezing these shorts out of their positions.
And that’s exactly what they did.
They shared their analysis on Reddit and whipped up a crusade narrative against what they saw as “vulture-like” institutions, seeking to profit off the demise of popular consumer brands.
As you can see, the share prices of these stocks went stratospheric as short positions unwound, causing huge losses at big hedge funds.
As such, identifying short squeeze stocks is also a great way to find the most volatile stocks.
Essentially, social media has become a useful tool for tracking the “herd mentality” behind short squeezes.
Admittedly, this is more of a qualitative measure than a quantitative one, with no hard-and-fast rules for detecting legit short squeezes. Instead, it requires discretion on your part to decide whether the hype is real or not.
How to Scan for Short Squeeze Stocks
Ok, so now we know what causes short squeezes and the metrics to identify them. But how do we find short squeeze stocks in real-time?
To do this, we need a stock scanner.
Finding Short Squeeze Stocks With Trade Ideas
Trade Ideas is one of the best stocks scanners on the market, and comes ready packed to find short squeeze stocks.
What I mean by this, is that it has a dedicated short squeeze “Channel”, that includes multiple, pre-configured short squeeze scans.
For example, one of the scans is called “Squeeeeze Me” and has the following criteria:
- Float > 5 million shares
- $3 < Price < $200
- Short % Float > 10%
- 5-day Average Volume > 300,000 shares
- Position in Year Range > 70th percentile
Another scan, called “Shorts Feeling The Pain”, imposes a slightly stricter threshold on the Short % Float:
- Price > $0.2
- Short % Float > 17%
- Change From Close > 0.1%
- Relative Volume > 1
- Position in Year Range > 15th percentile
The important thing to note is that all of the scans are fully customizable. You can change the numbers, add in any of the other 260 built-in filters, or start completely from scratch if you wish.
Finding Short Squeeze Stocks With Scanz
Scanz is another stock scanner well equipped to find short squeeze stocks.
The “Easy Scanner” contains a “Short View” tab that lets you rank stocks according to the all-important metrics for finding potential short squeezes, such as:
- Days to Cover
- Short Interest % Float
- Short Interest in Prior Month
And much more.
You can also apply extra filters such as market cap, volume, % price change, and float, to narrow your focus even further.
Read my Scanz review for a more in depth look at this platform. Alternatively, you can read this this Scanz vs Trade Ideas comparison to see how both platforms match up.
Examples of Short Squeeze Stocks
The screenshot below shows you what the scan results look like in Trade Ideas. Essentially, it’s a list of all the stocks that meet the scanning criteria, with relevant “short squeeze” metrics displayed alongside them.
Just as the scan itself can be customized, so too can the data columns. If there’s a certain metric you want to eye-ball alongside the scan results, simply add it in.
AEHR Test Systems (AEHR)
AEHR caught my eye because it was up 9.3% on the day. Remember, when heavily shorted stocks get some momentum behind them, it can make short sellers panic and exacerbate the rally.
On that note, you can see that AEHR had a short float percentage of 11.8%, and a short interest ratio (days to cover) of 1.11.
Neither of these are particularly high, however its breakout from a wedge pattern that day suggested further upside was coming. Read this article to learn how to identify breakout in stocks.
As you can see in the chart below, this is exactly what happened – it rallied about 36% in the space of a month!
KLX Energy Services (KLXE)
KLXE was another stock that flashed up on this scan the following day (19th October).
It had an incredibly low float of 10.9 million shares, a short float percentage of 10.5%, and days to cover of 4.73.
It was also breaking out of a bullish flag pattern on the daily chart, displaying the momentum I like to see in short squeeze stocks.
As you can see, there was a 50% rally in the stock’s price after that breakout! Once again, this shows how profitable short squeezes can be if you get in early.
Tesla
Tesla is another stock that managed to constantly confound the sceptics.
For many years, the short interest in Tesla frequently exceeded 30% of its float, until as recently as 2019.
Short sellers pointed to its long-running failure to turn a profit, meet production targets, and constant need for fresh financing. They believed that Musk’s unattainable ambitions had the share price in a state of suspense, destined for a “Wile E. Coyote” moment when they failed to materialize.
However… the day of reckoning never came.
Slowly but surely, electric vehicles entered the mainstream, Tesla overcame its scalability issues, and the company broke-even much sooner than expected.
As you can see in the chart below, this led to a massive short squeeze in Tesla from 2020-2022. Unsurprisingly, the short selling swiftly came to an end during this time. The short interest came down from 30% of float to about 3% today.
Summary
- A short squeeze refers to a situation where short sellers unwind their positions to cover losses (margin calls), which leads to a snowball effect of forced buying and a sudden spike in the stock’s price.
- Studying a company’s short interest as a percentage of float, or shares outstanding, is the best way to identify potential short squeeze stocks.
- As such, traders screen for stocks with high short interest in order to capitalise on any eventual short squeeze.
- In recent times, social media hype has generated so much buying pressure in certain stocks, that big institutions were forced to capitulate on their short positions – causing immense short squeezes.