It seems like every year there is a hot theme that takes the market by storm…we’ve seen it over the years in electric vehicles, cannabis, and crypto.
But right now…there’s no hotter theme than artificial intelligence.
Over the last few weeks, we’ve seen BuzzFeed, Inc. (NASDAQ: BZFD) gain up to 229%, BigBear.ai Holdings, Inc. (NYSE: BBAI) shot up by as much as 200%, and sector leader C3.ai, Inc. (NYSE: AI) has ripped 87% higher!
But these stocks aren’t having these big moves just because they’re in a hot sector, or because they’re good companies…
Or even because they have news…
They’re having these big gains for one reason only.
So today I’ll break down the mechanics of these moves with the latest runner.
Plus, I’ll show you what to look for, when to trade them, and how to potentially profit from these big gainers…
The Mechanics Of A Short Squeeze
A short squeeze is a market concept that can be tough for new traders to grasp…
If a stock is heavily shorted, why does it go up in price?
Here are the mechanics of how it works…
After a stock has a big premarket spike, short sellers like to bet that the stock will go back down. It makes sense in theory…
After all, penny stocks are trash and deserve to be shorted. The problem is, the strategy has become overcrowded. So when shorts begin to buy to cover, it can create epic moves.
When shorts enter the stock into a morning spike, they can use that morning high or the premarket high as their risk.
As the stock goes down, all the shorts want to take profits and get out. That means buying to cover to exit their positions.
And we know what buying does…
Buying is demand and makes prices go up.
So when you have a stock hitting daily lows and shorts start buying, it creates demand and causes the stock price to go up. As it goes higher, more and more shorts get nervous and want to exit.
This is why you can see monster moves to the upside without any dips. The short sellers can get so desperate to get out that they use market orders.
Let’s look at my number one trade idea from yesterday as an example. I sent my trade idea for it to subscribers in premarket — before it spiked a quick $1 per share. See how to get my next one here.
How Can You Spot Short Squeezes?
Look for stocks like Secoo Holding Limited (NASDAQ: SECO). The company jumped into the artificial intelligence hot sector with a ChatGPT news headline.
And it gapped up 124%!
SECO chart: 1-day, 2-minute candle — courtesy of StocksToTrade.com
In the first candle after the open it traded high volume and spiked to $4.22. And when it started to downtrend from there, that was likely where short sellers put their risk level.
As the stock went below VWAP, it looked like the shorts were in control. And shorts were likely adding to, and taking new positions just below VWAP.
But when it pulled back from VWAP, it formed a double bottom.
Buyers were holding it up and some short sellers probably started to buy to reduce their size.
From there the stock shot up on increasing volume. More shorts tried to keep it down by selling into the break above the daily high. But on the next dip, it held VWAP again. That’s when buying really got crazy and we saw big green candles to the upside.
Stocks in hot sectors with news, a low float, and high volume offer some of the best potential short squeezes.
When to Trade Short Squeezes And How To Potentially Profit From Them
You can see my entry price was at a whole dollar level. And it was at a point on the chart where anyone who shorted the stock in premarket or at the open would likely be in the red.
That’s a short seller panic point. That’s where I want to enter and join any potential move to the upside.
But these plays aren’t long-term holds. You can see SECO made its entire move within 15 minutes.
Remember, these stocks have these moves because short sellers are buying to cover to exit their positions. Not because of the news or because they’re good companies.
And as short squeezes go higher, they’ll start to take new positions risking a new high. And long traders will start to take profits. So these moves can reverse quickly.
Stay disciplined and trade the one specific move you’re looking for, then move on.
If you want my daily trade idea and plan delivered to your inbox in premarket — sign up here.
Subscribers actually get two picks per day — I give my top afternoon trade idea during a live Daily Double Down video.
Have a great day everyone. See you back here tomorrow.
Tim Bohen
Lead Trainer, StocksToTrade