Dear Fellow Trader:
After four days of selling on the Nasdaq, we took another hit in the Tech sector. But we also saw the AGGRESSIVE selling take a bit of a breather on Thursday. The December jobs report arrives Friday morning, and it’s uncertain what the market will do next.
The S&P 500 has tested its 20-day moving average, while the Russell 2000 broke under that level on Wednesday. That’s the first support level that needs to fall. But the gap between the 20- and the 50-day moving averages is significant.
The S&P 500 is fighting the 3,700 level, and the Russell is battling to hold 1,950. This can get messy if the markets don’t like the news on Friday. And I don’t know if bad news is bad news or good news is good news, or bad news is good news… or…
You get it.
Markets clearly showed a top pattern similar to what we witnessed in January 2022, August 2022 and August 2023. And with the selling pressure picking up, we’re likely to see a larger sell-off in the next 30 days or so.
But along the way… there will be some wild price swings. And by this, I mean there’s a high likelihood of short squeezes along the way. Let me explain what this means, and how you can take action.
What is a Short Squeeze?
A short squeeze is an event that happens in the stock market where people making a one-sided bet are caught off guard.
Here’s what happens:
We start with a stock that has a high level of short interest — this means a lot of people are betting the stock will fall, so they sold it short. All of a sudden, that stock price starts to jump… quickly.
It can be any number of things that force this squeeze. It might be positive company news. It might be new financial results. It could also be a sudden input of liquidity to the system. That is where we like to take advantage — with the latter.
So, here’s how a squeeze works.
A lot of investors borrow shares of a stock and sell them into the market. They hope to later buy the stock back at a lower price and pocket the difference. They’ll then return the shares to the lender.
But if the stock goes up, the short seller might have to buy the stock for higher than where they sold it into the open market. They will then rush back into the market to buy back shares to limit losses. This buying ends up driving the stock price higher because it creates new demand for the shares while others are buying that momentum.
This is where the “squeeze” comes in. As the price rises, more short sellers may panic and try to cover their positions. It creates a feedback loop where prices keep pushing higher, which forces more short sellers to buy and cover their losses.
Now, we can exploit a short squeeze by identifying stocks that have high short interest and are ripe for a price increase. We can do so by looking at the same stocks that have a high short interest, and then wait until we see a positive sentiment shift in the market.
The chart below shows the stocks with the highest short interest in the market today, via highshortinterest.com.
We can wait for some of these stocks to hit oversold levels on their Relative Strength Index (RSI) and Money Flow Index (MFI) at the same time before we start speculating.
We can keep this list open and look for volume to pick up in morning sessions, and look to ride the wave for a little while.
Or we can wait until our Equity Strength Signals turn positive across the board in the S&P 500 and Russell 2000 after a deep sell-off. If we look at the performance of Upstart (UPST). After a seven week sell-off in late 2022, our signals turned positive during the first week of November. Shares of UPST, which has high short interest, rallied from $26 to nearly $50 in just a few weeks.
We’ll talk more about finding these names and the optimal timing to speculate in the weeks ahead.
*This is for informational and educational purposes only. There is an inherent risk in trading, so trade at your own risk.
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I mean, it’s the stock market… there’ll always be winners and losses, too.
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*Stated results are from hypothetical options applied to real published trades from 10/30/23 – 12/26/23. The result was a 93.3% win rate, an average return of 13.7% including winners and losers and average hold time of less than 24 hours. Performance is not indicative of future results. Trade at your own risk and never risk more than you can afford to lose.