Investor sentiment is a constantly changing machine that shifts with every new piece of information. A stock can be shrouded with analyst pessimism one day and rally the next on a promising new announcement.
But there is also persistence in investor psychology that causes optimism to build on optimism and pessimism to build on itself, leading to so-called "excessive" optimism or pessimism. This is especially apparent in short-selling.
Short-selling is a strategy to cash-in on a stock dropping in price: the short-seller borrows shares today, immediately sells them, and then buys them back at a future date (and hopefully at a lower price) to return them to the owner and keep the difference as profit. The number of shares shorted indicates how bullish or bearish those investors currently are on a company.
When a stock becomes highly shorted amid deep pessimism, it can reach a sort of tipping point referred to as a "short squeeze." There are so many shares currently shorted that any bump up in price triggers a cascade in which short-sellers have to cover their positions by buying back the stock, which causes the stock to rally even further. Bears roar, and then shorts fall.
Interested in trading this trend? Here is a list of 10 stocks that are already seeing short covering, with significant decreases in shares shorted month-over-month. We screened these stocks for those that have also seen significant net insider buying over the last six months.
Use this list as a starting-off point for your own analysis. List sorted by net insider purchases as a percent of share float. (Click here to access free, interactive tools to analyze these ideas.)
1. Patriot National Bancorp
2. Auxilium Pharmaceuticals
3. Skilled Healthcare Group
4. ChinaCast Education
5. Primo Water
6. The McClatchy Company
8. Red Robin Gourmet Burgers
10. China Medical Technologies
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.
Kapitall's Eben Esterhuizen does not own any of the shares mentioned above. Short data and insider data sourced from Yahoo! Finance, all other data sourced from Finviz.
The Motley Fool owns shares of Red Robin Gourmet Burgers. 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.