Typically, by the time a stock has rebounded, it's probably too late for you to cash in on its rally. Market logic dictates that a soaring sock is inevitably bound to fall -- and if it's already peaking, it's going to happen sooner than later. But there's no rule of investing that can't be broken -- so a rallying stock may very well continue to defy gravity. But how do you know that the bubble won't blow up in your face?

Well, you don't. But the market behavior of more sophisticated traders can be a good litmus test.

Take short-sellers, for instance. They are among the most sophisticated types of investors, so it's worth having a look at what they're doing. When an investor "goes short," he's actually betting on his stock to lose; instead of buying low to sell high, he's selling high to buy low. A short-seller borrows shares from other investors and sells them on the open market. Sooner or later, he has to return them, and closes the short by buying back the same number of shares he initially borrowed. If he can buy back the stock at a lower price, he turns a profit off the difference.

Short-sellers take on unlimited risk because they have unlimited downside (theoretically, there's no upper limit on the stock's upside) -- if the stock keeps rising, they keep losing. For this reason, they tend to be quite a bit more sophisticated than the average investor -- so if they're shorting a stock, there's a pretty good chance that trouble lies ahead.

That said, if short-sellers cover their positions (i.e., buy back the borrowed shares), they think the upside potential of the stock outweighs the downside. This creates the potential for a short squeeze -- a scenario where demand from short-sellers pushes the stock price higher.

For this list, we wanted to identify the rebounding stocks that have crushed bearish short-sellers. All of the stocks mentioned below lagged the S&P 500 in 2010, but they've all outperformed the benchmark index in 2011. To refine the list, we looked at short-seller activity, and identified the rebounding stocks that have seen the largest decreases in short interest over the last month.

Short-sellers think these rebounding stocks have more upside than downside -- do you agree? (Click here to access free, interactive tools to analyze these ideas.)

1. GSI Commerce (Nasdaq: GSIC): The company's stock price declined from $25.39 to $23.23 in 2010, a price return of -8.51%. By contrast, the stock has gained 26.78% in 2011. Over the last month, shares shorted declined from 9.98M to 5.34M, a change that is equivalent to 7.47% of the company's total float of 62.13M shares.

2. The St. Joe Company (NYSE: JOE): The company's stock price declined from $28.89 to $21.85 in 2010, a price return of -24.37%. By contrast, the stock has gained 13.14% in 2011. Over the last month, shares shorted declined from 23.03M to 19.84M, a change that is equivalent to 3.95% of the company's total float of 80.83M shares.

3. Warner Music Group (NYSE: WMG): The company's stock price declined from $5.66 to $5.63 in 2010, a price return of -0.53%. By contrast, the stock has gained 31.97% in 2011. Over the last month, shares shorted declined from 4.62M to 3.62M, a change that is equivalent to 2.77% of the company's total float of 36.12M shares.

4. SUPERVALU (NYSE: SVU): The company's stock price declined from $12.71 to $9.63 in 2010, a price return of -24.23%. By contrast, the stock has gained 11.44% in 2011. Over the last month, shares shorted declined from 48.69M to 45.30M, a change that is equivalent to 1.62% of the company's total float of 209.86M shares.

5. MB Financial (Nasdaq: MBFI): The company's stock price declined from $19.71 to $17.32 in 2010, a price return of -12.13%. By contrast, the stock has gained 15.14% in 2011. Over the last month, shares shorted declined from 3.08M to 2.43M, a change that is equivalent to 1.3% of the company's total float of 50.01M shares.

6. Conceptus (Nasdaq: CPTS): The company's stock price declined from $18.76 to $13.8 in 2010, a price return of -26.44%. By contrast, the stock has gained 10.29% in 2011. Over the last month, shares shorted declined from 3.03M to 2.68M, a change that is equivalent to 1.27% of the company's total float of 27.56M shares.

7. Century Aluminum (Nasdaq: CENX): The company's stock price declined from $16.19 to $15.53 in 2010, a price return of -4.08%. By contrast, the stock has gained 18.09% in 2011. Over the last month, shares shorted declined from 5.48M to 4.79M, a change that is equivalent to 1.24% of the company's total float of 55.85M shares.

Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research. Note: The numbers on top of items represent the forward P/E ratio, if available.


Kapitall's Eben Esterhuizen does not own shares of any companies mentioned.

Motley Fool Options has recommended buying calls on SUPERVALU. The Fool owns shares of SUPERVALU. 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.