Short squeezes were a sensation a couple of years ago. Beaten-down stocks with overwhelming short-selling became lottery tickets that exploded for massive investment returns in a matter of days, sometimes hours. The stock-trading fun fizzled out in 2022 when the bear market turned market sentiment negative. However, the constant doom and gloom may have set the stage for a short-squeeze resurgence. Some stocks have been shorted so heavily that they've fallen as much as 95% from their highs.
Some of these stocks began getting squeezed in May, posting rapid gains ranging from 78% to 250% in weeks. Here is what you need to know about short squeezes (hint: they're extremely risky) and which stocks could continue popping off over the weeks ahead.
What causes a short squeeze?
Typically, most investors buy stocks because they think the share price will go higher over time, making them long-term investors. Shorting a stock is the opposite side of that concept; someone shorts a stock because they think the price will fall. Short-selling is when someone borrows shares of stock to sell them. Shorting a stock creates the obligation to repay those shares in the future, a crucial point.
To make money shorting a stock, someone must short at a price and then repurchase the shares (hopefully, at a lower price). Repaying the borrowed shares closes the trade and is called short covering. So, if someone shorted shares of XYZ at $100 per share and covered at $80, they would profit from the $20 difference for each share they shorted.
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But just like buyers can act irrationally, so can short-sellers. Sometimes so many people short a stock that it ends up backfiring. Other buyers jump in and start buying up shares, creating pent-up buying energy. In such an event (sometimes coordinated through online group communications), the overwhelming buying can quickly send share prices up. The short sellers start selling off to cover their buy-ins, but have trouble finding enough available shares for sale. The shares they do find are priced at abnormally high levels, an event called a short squeeze.
It must be said that short squeezes are very speculative. The price action in these events is not fundamentally driven and is more like gambling than investing. Short squeezes are fun for the non-short stock owners, but only until the music stops and there are no more buyers. Get into a short squeeze too late, and you could suffer losses too as people frantically sell to lock in their gains. Remember only to risk money that you're ok with losing because that could happen.
These stocks have squeezed and could keep on squeezing
Now that you know the potential risk and rewards of short squeezes, here are four potential stocks to consider. These all began rallying weeks ago but still have (according to the most recent data) high short-selling activity. The percentages in the chart below represent how much of the stock's publicly traded shares are sold short and must still be covered by sellers.
1. Carvana
Carvana (CVNA 8.79%) is a digital car-buying marketplace. The stock has gained 250% since May 1 and remains heavily shorted, with 68% of public shares sold short.
It became a popular short stock due to the company's lack of profits, large debt load, and rising interest rates making vehicles less affordable for buyers. The company has begun to show some signs of life but remains very speculative moving forward, which could explain the continued efforts from short-sellers.
2. Upstart Holdings
Upstart Holdings (UPST 2.76%) is a technology company that uses artificial intelligence (AI) to decide what consumer loan applications to approve. The stock has gained 182% since May but has seen short-selling activity pick up as its share price increases. Nearly 35% of public shares are sold short at the moment.
The stock became a sensation when share prices soared from $20 to $400 in one year in 2021. Rising interest rates burst that bubble and crushed the business as Upstart had difficulty selling loans and began stockpiling them on its balance sheet. Interest rates have stabilized recently, and Upstart has begun addressing its funding issues. However, the company's operating results haven't meaningfully bounced back yet.
3. Wayfair
Wayfair (W 2.08%) is an e-commerce company specializing in home goods and decor. Shares are up 78% since May 1, yet short-sellers are still bearish on the stock. Roughly half of the publicly traded shares are still sold short.
The company's financial situation has continually deteriorated; the business burns cash, and its cash pile is steadily dwindling. Revenue is falling, so there's no growth story either, meaning the business may have to cut costs to survive over the long term. The stock rallied, but recent insider selling could be an ominous sign for Wayfair moving forward.
4. C3.ai
C3.ai (AI 3.02%) is a technology company that sells AI software applications for enterprises. Shares have soared 110% since the beginning of May. Short-sellers have remained resilient; roughly a third of publicly traded shares remain shorted.
This AI company has some fundamental questions it must answer. Revenue growth halted because management changed the billing model, and it's still years away from turning a meaningful profit. The stock rallied hard in recent weeks, but it's a good chance that the hype for AI stocks drove the price action, not the company's fundamentals.
