There may be some trading opportunities with stocks that have been beaten down that are heavily shorted. A short squeeze exists when a substantial number of short sellers have shorted a stock, and there is unexpected positive news on a stock, which causes the price of the stock to spike by a large amount, because all the short sellers have to rush to cover their positions by buying in their shares. This scramble to buy shares often generates margin calls, which causes more buying and higher stock prices.
Short squeeze opportunities have several metrics that can be used for comparison. One of the most common metrics is the Short Interest Ratio, also known as the Days to Cover. This measurement is the number of days it would take the short sellers to buy in their positions based on the average daily trading volume. The more days it would take to cover, the higher the ratio. Another analysis or metric is the number of shares that are currently shorted as a percent of the float, called the Short Percent of Float. The float is the number of shares that are traded on an active basis. The higher the percentage of shorted shares, the greater the chance that an upside surprise would cause the price to go up.
Here is an example. ITT Educational Services (ESI) has a short interest ratio of 7.9 and an incredible 70% of the float is currently shorted. The stock has a trailing price to earnings ratio of 7 and a forward PE of 8.
Exact Sciences Corporation (EXAS) has a short interest ratio of 27.1, which means that it would take over 27 days for the short sellers to cover their positions, based on the current average trading volume. This is a very high number. About 35% of the float is shorted, which is a very large percentage.
Trulia (TRLA) has a short interest ratio of 6.6 with 44% of the float currently shorted. The company reported a loss of 88 cents for the latest quarter, however, revenues spiked by 127%.
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Disclosure: Author didn't own any of the above at the time the article was written.