The Retail Stock Ripe for a Short Squeeze

Short interest can be used to identify uptrending stocks with potential buying power sitting on the sidelines

Apr 27, 2017 at 2:32 PM
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Sentiment is a key element of our three-tiered approach to trading, known as Expectational Analysis®. By combining sentiment, or the collective expectations of investors, with fundamental and technical analysis, we're able to better identify situations in which an uptrending stock may have buying power sitting on the sidelines -- and the potential to move even higher. Conversely, we're also able to see if buying power has been depleted on a downtrending stock, meaning there's little left to help lift the shares. One such sentiment indicator we use is short interest, which can help to identify how much skepticism traders have levied toward a specific stock.

Short Interest as a Contrarian Indicator

At its most basic, traders will short a stock by borrowing shares from a broker without actually buying them. Therefore, the goal is for the stock's price to decline, allowing the short seller to buy back the shares at a lower cost to replace the borrowed ones -- and pocket the difference. However, as a stock starts to rally, short sellers may be forced to start buying back the shares to limit losses -- creating a "short-squeeze" -- which in turn may lead to even more tailwinds for the shares. Additionally, a heavy amount of short interest can often be referred to as "sideline cash," which is available to help assist a stock in its upward trajectory.

On the flip side, a stock that's been in a steady downtrend could see its losses accumulate as short sellers pile on. Shorting a stock creates selling pressure, which could encourage more traders to bet against the shares and/or give current short sellers little reason to exit their winning positions. This is often referred to as short sellers or bears being "in control" of a stock.

SCSS Stock Could Be Due for a Short Squeeze

Shares of Select Comfort gapped to a two-year high of $33.29 on April 20 after the mattress retailer turned in a standout earnings report. SCSS stock eventually settled the session up 28%. More recently, the stock was seen trading at $31.85, but maintaining a 40.8% year-to-date advance. While short interest edged down in the most recent reporting period, it still accounts for a lofty 16% of SCSS' available float. Plus, it would take more than eight sessions to cover these bearish bets, at the stock's average pace of trading, meaning there's ample cash available to spark a short-covering rally.

Sanchez Energy Stock May Be One to Avoid

In the most recent edition of Monday Morning Outlook, Schaeffer's Senior V.P. of Research Todd Salamone said "the energy sector is a group to avoid, as it is overcrowded and underperforming." Sanchez Energy Corp (NYSE:SN) is an oil stock that has turned in a dismal technical performance in recent months, down 47% since peaking in late January to trade at $7.60. Amid this sharp sell-off, short interest on SN stock has surged 63.5%, and is now at its highest perch since August 2015. With bears seemingly in control of this energy stock, additional losses could be on the horizon.

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