Market momentum is Red. Cash remains your best option… today was all about short squeeze and extremely weak momentum. Only three companies hit new 52-week highs, and 469 stocks hit 52-week lows. In addition, not one S&P 500 stock completed the week up above 10%. Meanwhile, 205, or 40% of the index, dropped by double-digit percentage points this week.
The markets finished in the green today… but there was a lot of deception here. Yesterday, I talked about the Relative Strength Index and how it can be a tool to determine a possible bounce back in stocks. Boy… did it turn out to deliver.
It signaled today that a short squeeze might be in play. And today, there was a massive one that shocked a lot of short-sellers in the market.
The market itself didn’t do much today regarding a snapback rally. Instead, we saw smaller gains fueled heavily by stocks with a very high short interest. What on earth does that mean? I’m going to show you right now.
The Squeeze Is On
Short selling is quite popular these days. With the markets heading lower, and expensive tech stocks experiencing a dramatic decline in their valuations, people are actively betting against these companies.
I’ve mentioned a bunch of these stocks before. There are hundreds of stocks trading at north of 10 times revenue. And people who expect stocks like these to drop like a stone engage in short selling. The short-selling process is pretty simple…
A Short Seller might be a hedge fund, day trader, or anyone with a brokerage account. That person will BORROW stock shares from someone else who is long the stock. Since that person wants to hold the stock for a longer time frame and doesn’t care if it goes up or down, they will lend it to the short seller for a fee.
That fee might be a few percentage points or MUCH higher depending on the market volatility and stock volatility. The short seller – having borrowed the stock – will sell that stock into the market.
If they sell a share for $50… they will hold onto that money. If the stock drops to $30 over the month, they can repurchase it. As a result, they pay for the stock and keep the $20 difference. They can then return the stock to the original owner, plus the fees.
Now if the stock goes higher than $50, the short seller is in trouble. If it goes up to $75, they will want to repurchase it… or risk it going even higher. At that point, they have lost $25. And they still owe the fees to the original owner.
How the Squeeze Starts
Now a short squeeze happens when a lot of short-sellers try to repurchase the stock simultaneously. Maybe there is positive news about the stock, or perhaps there is a strong earnings report that surprises.
When this happens, not only are the short-sellers trying to buy the stock to close their position, but other traders recognize the frenzy and pile into the trade. This results in a “Squeeze” that pushes the stock higher, forcing the short sellers to buy the stock at a higher price.
These can be fast and furious, especially on stocks with crowded short interest. The latter term is defined as the number of shares shorted out of the total number available on the market.
So, if a stock’s short interest sits at 30%, 30 out of every 100 shares available are being shorted. Such high short interest is typically linked to macroeconomic conditions, concerns about valuations, or other factors that suggest that the stock should move lower for longer.
You can always find a list with the highest short interest at HighShortInterest.com. Currently, 14 companies have a short interest of over 30% on the website’s list. (Finviz, however, lists 33 total).
And as we look at this list, we can see a few familiar names on the top performers for the day. Here is what Finviz lists as the top performers today, with a short float above 30%.
You’ll notice that many of the same names were the top performers on Friday. Today wasn’t a day for serious buyers. Instead, it was a day for quadruple witching, negative momentum, short-covering, and extreme caution.
I expect the selling will resume next week… and all summer long. Remember that cash is your friend.