As demonstrated by Apollo Group (APOL) today, a short squeeze can be a catalyst for a huge breakout. A squeeze occurs when you have a stock that has attracted numerous short sellers. As the stock begins to move higher, more and more of these short sellers will hit their stops. This forces them to buy back their shares around the same time, quickly pushing the stock price up much higher. A good rule to remember is the higher the percentage of shares that are short, the stronger the potential squeeze. For comparison’s sake, Apollo had a short float of 21%.
Here’s a chart of how powerful a short squeeze can be – resulted in a 27% move today in APOL on huge volume
Now that you know how a short squeeze works, let me show you how you can create a simple screen to find the perfect short squeeze trading candidates. My screen consists of only three simple criteria, so you should have no trouble creating your own using free tools available online.
Let’s get started…
First, I want to begin our screen using the site Finviz.com. [Note: I’m not affiliated with Finviz—nor do I receive any favors for sending you to their stock screener. From my experience, this is the best free screener online.]
Go to Finviz and select “Screener” from the top menu bar. This will take you to the main stock screen page where you can begin to enter the following criteria:
1. Search for liquid stocks.
You’ll only want to deal with liquid stocks when searching for potential trades. And that’s not just true for our short squeeze screen. You should always confine your searches to stocks that trade regularly. After all, the last thing you need is to get stuck with a stock that you can’t sell.
Under the main “Descriptive” tab in the screener, you should select stocks with “Average Volume” of “Over 500k”. This will weed out all of those low-volume stocks you’ll want to avoid.
2. Find the shorts.
Now it’s time to find the stocks with heavy short interest. Click on the “Float Short” tab and you will see a drop-down menu with plenty of choices. For this screen, we obviously want stocks with the highest short interest possible. Select “Over 15%” and you’re almost ready to trade…
3. Pinpointing the best breakout candidates
Even after narrowing down our trading universe with the first two criteria, you’ll notice that you’re still left with a ton of charts to go over. Now, your mission will be finding the stocks in this group that are closest to breaking out.
For this final step, you’ll have to select the “Technical” tab from the filters menu:
From this menu, you can narrow your results to only the best performing stocks. I recommend starting with the “50-Day High/Low” option. Select “0-10% below High” under this tab to pull up stocks making new 50-day highs. This should leave you with a manageable list of tickers you can examine for potential trades.
Here’s where a little bit of trading knowledge comes into play. After you make your list, pull up the charts for a closer look. Which ones are the closest to breaking out of a range? Are any of these stocks forming bullish patterns such as inverse head and shoulders or ascending triangles? If so, these are the names you should add to your watch list.
Keep a close watch on the chart. You are looking for the same trends you were when you spotted the potential squeeze- just opposite. Volume will, without doubt, spike during the run-up due to the flood of short covering. This is the short squeeze in action. Some squeezes, such as the aforementioned Apollo squeeze, can take place in a matter of hours. Some take a little longer to develop.
Also, for those more drawn out short squeezes, continue to watch the short interest levels. As the shorts leave the stock, the number should decrease. Make a determination regarding what the “normal” short interest of that stock should be and stick to it.
Those who use fundamental analysis might have a very good reason for shorting the stock so aggressively, but as a trader who uses technical analysis, I dont care what that reason is, but that is true only if I always respect my stop loss. While short squeeze plays can reward one with quick and big profits, they sometimes offer no second chances if you disregard your stop loss.