Right now, lots of investors are betting against Hawaiian Holdings (NASDAQ:HA), the parent of Hawaiian Airlines. That might seem like bad news for bulls (like me), but the story's not quite that simple.

Hawaiian Airlines' business fundamentals are actually improving, with unit revenue expected to start growing again in the just-ended third quarter. Furthermore, analysts expect Hawaiian to show solid earnings growth over the next few quarters. This sets the table for a possible "short squeeze" following Hawaiian's earnings report next week.

What's a short squeeze, anyway?
When investors bet against a stock -- by "shorting" it, which entails borrowing the stock and then selling it -- they must eventually repurchase the shares they have sold (to return them to the lender). If good news regarding the company causes the stock to rise quickly, short sellers may be forced to buy back the stock in order to cut their losses or avoid a margin call.

When investors short a stock en masse, good news for the company can have an exaggerated effect on the stock. If a large number of short sellers try to close their positions simultaneously, this additional demand for the stock can outrun the supply. The stock price therefore rises, to entice more shareholders to sell.

However, this increase in the stock price can force even more short-sellers to close out their positions, creating additional buying demand. This feedback loop can continue for quite a while, with a rising stock price creating more buying demand among desperate short sellers, causing the price to rise even more. This is a short squeeze, and it can lead to spectacular gains for investors in heavily shorted stocks.

Short squeeze in practice
(NASDAQ:NFLX) is a great recent example of a short squeeze in practice. Last fall, more than 30% of the Netflix float (the shares available for trading) was sold short. As Netflix's stock price began to rise, short sellers began heading for the exits. This process was punctuated by two clear "short squeezes", following Netflix's January and April earnings reports.

NFLX Chart

Netflix One-Year Price Chart, data by YCharts

The high short interest in Netflix last fall proved to be a big boon for Netflix investors. The buying demand from short sellers looking to close their positions probably caused the stock to rise a lot faster than it would have otherwise.

The Hawaiian opportunity
Today, Hawaiian Holdings stock could be primed for a similar short squeeze. As I pointed out last month, short sellers began attacking Hawaiian in earnest after the company reported weak Q4 earnings in January. Despite several signs of improvement since then, short interest has continued to rise, reaching 25% of Hawaiian's float by the end of September.

HA Percent of Float Short Chart

HA Percent of Float Short data by YCharts

Despite this short-selling activity, Hawaiian Holdings stock is nearing the multiyear high it set in late July, and is up almost 50% from the lows it hit this spring. In other words, short sellers are already feeling significant pain.

HA Chart

Hawaiian Holdings Five-Year Price Chart, data by YCharts

If Hawaiian provides a solid Q4 forecast, which seems likely in light of the relatively favorable conditions it's facing, that could be enough to start a short squeeze. With the stock currently trading for less than seven times expected 2014 earnings, it has plenty of room to run, especially if earnings estimates start to rise again.

Foolish bottom line
Short sellers have been piling into Hawaiian Holdings this year, but they are not guaranteed to have their way. Bullish investors are equally excited about Hawaiian Holdings. In fact, Hirzel Capital Management -- Hawaiian's largest shareholder -- has been increasing its position aggressively, and now owns more than 10% of the company's stock.

With the company's outlook improving, shorts may have missed their opportunity. If Hawaiian's forward guidance meets or beats expectations, the stock could be propelled much higher by a short squeeze.

Fool contributor Adam Levine-Weinberg owns shares of Hawaiian Holdings and is long October $6 calls on Hawaiian Holdings. Adam Levine-Weinberg is short shares of Netflix and is long December 2013 $275 puts on Netflix. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.