Everyone loves to dunk on Jim Cramer.
Say what you want about the guy – he’s been around longer than most traders have been alive, and he’s seen it all.
I don’t keep up with his show these days, but I will say this: His first book, “Confessions of a Street Addict,” is an absolute classic.
Highly recommend it if you want a raw, behind-the-scenes look at old-school Wall Street. It’s pretty wild.
This week, Cramer made headlines again, pushing back on the shorts in Kohl’s (KSS) and comparing the setup to the infamous GameStop (GME) squeeze from a few years back.
Honestly? He might be onto something.
There’s a lot of talk right now about short squeezes – and for good reason.
They’re happening again… in weird places… and with violent outcomes.
But let’s be clear: Short squeezes have always been part of the game.
And if you understand how and why they happen, you can put yourself on the right side of them – over and over again.
It’s Always Been This Way
Short-sellers are regularly getting squeezed.
This is not a new thing. But it’s definitely an underappreciated aspect of markets.
You hear me say this all the time – stock prices don’t move up and down based on “fundamentals.”
Prices move based on positioning.
Sometimes big funds don’t have enough exposure to a particular stock or group of stocks, and the need to buy aggressively – and this behavior pushes prices higher.
Other times, these massive institutions that manage billions of dollars are long the same stocks – but they own way too much.
The massive shift in the other direction – all of them selling billions of dollars worth of the same stock or stocks at the same time – causes huge declines in their prices.
In many other even infamous cases, these hedge funds and other heavy hitters are short certain stocks, placing bets prices are going to decline.
Understanding the mechanics of these markets is a huge advantage. And it’s not complicated.
Let’s break it down…
If you are shorting a stock, technically what’s happening behind the scenes is you’re borrowing shares from your broker, keeping a margin balance there as collateral.
Those shares are sold into the open market with the goal of buying them all back at much lower prices, then returning those shares to the broker but keeping the cash spread for yourself.
Great trade!
But sometimes – a lot of times, actually – prices of those heavily shorted shares start to go up instead.
And now all those huge institutions are wrong, and they’re losing a lot of money, and fast.
Not only are they paying high margin interest rates while those shares are being borrowed. They’re also going to be forced to buy those shares at higher prices.
They’re losing on both ends.
For the big hedge fund/asset management world, the goal is to make money. Not to lose it.
In some, more extreme cases, short interest is so high and the race to buy back shares gets so accelerated that prices can go up 100%, 300%… even more… and in a very short period of time. We’re talking days.
These are what’s commonly referred to among Wall Street traders as “short squeezes.”
Here at TrendLabs we pay particularly close attention to the stocks with the highest short interest – those most vulnerable for a short squeeze.
We do this better than anyone.
Take a look at what I’m talking about:
Source data for this table is released every two weeks. It’s a treasure-chest. But even if you can find it, it’s a mess.
But we organize it all.
We sort the stocks where the short interest has increased the most, report over report.
Here’s a catch: If you’re using total shorts, you’re only going to get a lot of the biggest names.
We’d rather adjust that dollar amount of the increase in short interest by the total market capitalization of the company.
Take a look at the names on the top of the list from the most recent report.
Jim Cramer’s KSS just had a 120% rally in two days.
Opendoor Technologies (OPEN) was up almost 10x in less than a month and was triple over the last few days of that move.
Shorts were increasing their positions in these stocks the most.
They got crushed. And we’re thrilled about that.
It’s nothing new. But it definitely falls under the radar.
I have no idea why.
We do as good of a job as anyone on Wall Street organizing and sorting this data in ways we can actually use it to profit in the market.
One last thing I’ll mention here is just because there’s massive short interest and the stock is super-vulnerable to squeeze doesn’t mean we want to buy it blindly.
It’s quite the opposite. There’s a reason these stocks are being shorted so aggressively. They’re not exactly revolutionizing their industries.
Usually the company is in bad shape. But by the time the squeeze comes, positioning is already at the point where all the bad news is priced in.
And then – boom! – the squeeze is on.
Wen Moon?
“So when do we know the squeeze is on? How do we know the short sellers are being forced to cover?”
Look at momentum. Price doesn’t lie.
As soon as the trend shifts, that’s when you know there’s a good chance it’s happening.
We sort by rate of change, we use VWAPs anchored to prior highs, and we wait for prices to break out above those key thresholds before we get involved.
And remember: Margin clerks don’t use limit orders.
If you can’t cover your margin in time, and those margin clerks at the broker need to liquidate your position, they’re not going to work the orders throughout the day and try to get you the best price…
They’re going to spray the market. Any fill they get, it doesn’t matter.
They’ll buy them back at any price, and the short seller is paying for it all.
It’s great.
Stay sharp,
JC Parets, CMT
Founder, TrendLabs