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Wednesday, December 5, 2012 - 13:00
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Wednesday, December 5, 2012 - 13:00
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Wednesday, December 5, 2012 - 13:00

3 Short-Squeeze Stocks Ready to Rally

Wednesday, December 05, 2012 1:00 PM

One of the quickest and easiest ways to make gains in the stock market is to own a stock that's experiencing a short squeeze. A short squeeze happens when a stock is heavily shorted, but unexpected good news or other factors start lifting the price higher. Spooked by the possibility of losing more money, short sellers rush to cover their short positions, resulting in an upward buying pressure that powers shares higher. As the stock rises, even more short sellers are forced to close their positions by buying back the stock. This creates an avalanche effect that can send shares skyrocketing.

One of history's most dramatic short squeezes occurred in 2008, when Porsche SE announced it would raise its stake in Volkswagen to 75%. The announcement pushed Volkswagen 187% higher, briefly making it the most valuable company on Earth. Not all short squeezes are this dramatic, but they still create a powerful opportunity for nimble investors to profit.

When investigating potential short squeeze candidates, you can check a stock's short interest ratio on websites such as Yahoo!Finance, Bloomberg or Morningstar. The higher the short interest ratio, the more likely the stock will experience a short-squeeze rally. In addition, it's important to focus on relatively solid stocks that are heavily shorted but are trending upward. Existing upward momentum combined with a high short ratio may be the catalyst needed to spark a short-squeeze buying explosion.

Here are three stocks I have identified as strong candidates for a potential short squeeze. They are all strong stocks that currently boast high short ratios, so even the smallest bullish event could send these stocks soaring...

1. Royal Bank of Canada (NYSE: RY)
Not only does this bank stock provide a 4.2% dividend yield, but it's among the largest banks in North America, with more than $800 billion in assets. Canada missed out on the financial rout suffered in the United States. However, despite a strong balance sheet, many investors believe Canada is on shaky ground financially and have shorted this flagship bank.

The short ratio is above 25 with more than 13 million shares short. A daily close above $60 would trigger my long entry into this stock.

2. Chungwa Telecom (NYSE: CHT)
This Taiwanese telecom company boasts a dividend yield of more than 4%, but it has a short ratio of more than 25 with more than 4 million shares short. Chungwa is the largest telecom company in Taiwan but investors are afraid the nation cannot sustain its growth rate. Shares have been uptrending despite the heavy short interest, as you can see in the chart below. This stock looks like a buy at these levels.

3. Thomson Reuters (Nasdaq: TRI)
The second fiddle to Bloomberg in the financial information industry, Thomson Reuters has the highest short ratio of the three stocks listed here, at 35. Yielding nearly 5%, the stock is a favorite short candidate as investors challenge its ability to sustain the growth it needs to stay afloat.

Thomson Reuters earns more than $1 billion in free cash each year and has a solid balance sheet. The high short ratio makes it an ideal candidate for a short squeeze. Unlike the other two stocks, Thomson Reuters has been downtrending since mid-September. My strategy would be to buy this stock on a breakout above the 200-day simple moving average at $28 and expect this rise to trigger an aggressive short-squeeze move higher.

Risks to Consider: Investors have reasons to short stocks. No one knows for certain that a short squeeze will happen. All we can do is use data to choose the stocks most likely to experience a short squeeze. Investing in the hopes of a short squeeze occurring is very risky and speculative, so always be sure to use stops and position size based on your risk tolerance when investing.

Action to Take --> However, it is within this risk that huge profits exist. I like all three of these stocks as potential short squeeze candidates. In addition, their high dividend yields and solid balance sheets make these stocks wise choices for long-term portfolios.

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David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.