The “risk on” trade is back so far this year…
Even after pulling back slightly over the past couple days, the S&P 500 Index is still up around 7% in 2023. And the tech-heavy Nasdaq Composite Index is up roughly 14%.
Being too “bearish” and sitting on the sidelines as stocks rally will hurt your portfolio.
But that’s only half the story…
Being too “bearish” and making active bets against stocks as they rally can be worse.
Hedge funds love to play this game…
You see, hedge funds do a ton of research. As part of that research, they develop models and try to get a leg up on everyday investors by betting against stocks – or hedging.
But with folks taking on more risk so far in 2023, hedge funds are now feeling the heat. And as you’ll see in this essay, it could mean huge gains for everyday investors like us…
With the Power Gauge’s help, I’ve found more than 60 stocks that could be in this position. And today, we’ll look at one company in particular…
Let’s start with the basics of “short selling“…
Short selling is a trading strategy in which an investor bets against a stock.
The investor believes the stock will head lower. So he borrows shares from his broker at their current price and sells them into the market. Then, at some point in the future, he plans to buy them back at a cheaper price. If the investor’s plan works, he’ll book a profit.
So if you sell 100 shares that you don’t own, you’re short those shares. And you need to buy them back to close (or “cover”) the trade. That’s known as “short covering.”
Short covering is serious business when the market breaks out…
If investors hold too large of a short position on a stock, they can lose money quickly.
You see, short covering can result in a seemingly endless loop. Increased demand for a stock to cover short positions leads to even higher prices. In turn, these higher prices lead to even more short covering. And the loop repeats until the short sellers get crushed.
This type of “short squeeze” can cause a stock’s price to rise fast. And in turn, it can lead to significant losses for short sellers. That’s happening to hedge funds in the current rally.
But the thing is… we can take the other side of this trade.
Specifically, the Power Gauge helps us find the best ways to profit from short squeezes…
For starters, our one-of-a-kind system tells us which companies have strong fundamentals. We can even figure out whether Wall Street analysts are increasing their estimates. And perhaps most importantly, we can run screens using several technical indicators as well.
In the end, we can find stocks on the verge of breaking out for one reason or another. And if the stocks also have high short interest, we can capitalize on a developing short squeeze.
Right now, more than 60 stocks fit this narrative. And one company that stands out is online retailer Wayfair (W).
The Power Gauge currently ranks Wayfair as “bullish” overall. And the company has excellent fundamentals…
For example, its price-to-sales ratio is about 0.6 today. That’s strong relative to the company’s peers. And it’s good enough for a “bullish” grade from the Power Gauge.
Also, Wayfair’s return on equity is roughly 60%. This factor is “very bullish” in the system.
But its short interest is “very bearish.” That means short sellers like hedge funds are betting against it at an extreme level right now. You can see this factor in the Experts category…
Despite that extreme negativity from the hedge-fund crowd, Wayfair is headed higher…
In fact, the stock is soaring! It’s up around 97% since the start of the year.
But again, the Power Gauge shows us that Wayfair’s short interest is still at an extreme level. That tells us the stock can still squeeze out plenty of negative hedge-fund bets.
This is exactly the kind of setup we want to find in today’s changing market. As stocks rally, plenty of short squeezes will occur. And finding them is easy with the Power Gauge.
Good investing,
Pete Carmasino
