The world is a scary place for investors right now…
Russia’s war in Ukraine continues… Inflation is at a multidecade high… We’re still seeing supply-chain shortages… And the Federal Reserve is raising interest rates.
With all of that uncertainty in mind, it’s tempting to bet against the market.
But in reality… it makes more sense to do the exact opposite.
You see, investor “fear” is increasing. But as I’ll show you today, we can use this shift in sentiment to our advantage. We can beat investor fear and profit at the same time…
Simply put, we’re looking for stocks that deserve better treatment than they’re getting from the market. In other words, we want to find stocks that a lot of investors are betting against.
To uncover them, we’ll use a factor called “short interest.”
Short interest is simply the measure of investors betting against a stock. And importantly, stocks with high short interest have the potential to pay out huge gains. It has to do with the infamous “short squeeze” and how the stock’s price can change when fear unwinds.
When you buy a stock, you can hold it as long as you want. You own your shares. So you can choose to close your position tomorrow, next month, or 30 years from now.
But generally speaking, short sellers don’t have this privilege…
That’s because most investors open short positions with loans from a brokerage firm. You’ve likely heard this referred to as “margin.” That’s where things get interesting…
Short positions are capable of infinite losses. No kidding. That’s because no limit exists on how high their prices can go.
As a result, it’s critical to the firm that a loan on a short position doesn’t get out of control. So the firm will decide to close short trades for investors who are in over their heads.
To close these trades, the firm can liquidate an investor’s assets and buy back the stocks that the investor has shorted.
Obviously, that’s the extreme scenario. It isn’t how every case plays out. But it does happen every day across every brokerage firm that offers margin to short sellers.
And by the way, it’s not just mandatory “buying and covering” short positions. Short sellers could also look at a rising stock and voluntarily decide to buy shares to reduce or close (cover) their short positions.
If this happens to enough short sellers of a single stock at the same time, the buying and covering can result in a “short squeeze” rally.
Now, let’s put this knowledge to use…
First, we want to identify stocks with high short interest. A couple of examples will help us understand what we’re looking for…
Consumer-electronics giant Apple (AAPL) currently has 108.9 million shares sold short. That might sound like a lot. But in reality, it’s trivial compared to the total number of shares outstanding (16.3 billion). That means only 0.7% of AAPL shares are sold short today.
Meanwhile, shipping company Eagle Bulk Shipping (EGLE) has far fewer shares sold short right now – a mere 1.25 million. But importantly, the company only has 13.6 million shares outstanding. So short interest in the stock is much higher… It’s at roughly 9.2% today.
This sort of information is available on most financial websites. But I prefer to simplify my burden using the “short interest” factor within our Power Gauge system… It crunches the numbers and immediately tells me whether a particular percentage is benign or noteworthy.
The Power Gauge ranks Apple as “very bullish” in the short interest factor. That tells us it’s benign. And Eagle Bulk Shipping’s short interest rank is “very bearish.” That tells us it’s noteworthy.
So we know the short interest in Eagle Bulk Shipping is noteworthy. Next, we want to evaluate the opportunity. We can do that in many ways. But once again, I turn to the Power Gauge…
The Power Gauge gives Eagle Bulk Shipping a “very bullish” overall rating today. That alone tells us the stock deserves more respect right now than the short sellers are giving it.
In other words, it’s a showdown between the “very bearish” grade for short interest and the other 19 Power Gauge factors that combine to produce a “very bullish” overall rating.
Investor fear is on the rise. But importantly, we can use it to our advantage. When a stock has high short interest but looks attractive overall, it could create a big profit opportunity.
That’s the case with Eagle Bulk Shipping right now. And it’s an opportunity that you should consider.
Good investing,
Marc Gerstein
