Why Tracking Heavily Shorted Stocks Makes Sense

When I look at potential trading opportunities, I like to scan for stocks that have high short selling positions on them. These are traders betting against the stock.

While there’s always some validity to why a stock becomes a short selling target, that's not always the case; this is where I see contrarian trading opportunities.

Going against the grain does work, but there have been cases where a contrarian strategy has blown up in my face. The key here, like any other situation, is to make sure you have an exit strategy. So while some traders view heavy short selling positions as a negative, I view extreme short selling as a possible trade opportunity to make money by betting against the herd.

An excellent example of this is the case with Tesla Motors, Inc. (TSLA), which saw 62.9% of its float shorted in mid-April, when the stock was trading at the $46.00 level. In my view, the amount of short selling was extreme and worthy of a look for the aggressive trader. The company subsequently reported some numbers and its outlook—all excellent.

The result was a significant pop in the share price of Tesla from investors' buying and short-sellers covering. The stock surged 147% in about six weeks, with the shorts falling to 36.9% of the float as of May 15, according to data on Yahoo! Finance. A call option trade on Tesla would have yielded even greater returns due to the leverage used.

Take a look at the chart of Tesla below, and note the two major opening upside gaps as indicated by the purple circles, based on my technical analysis.

Another short selling squeeze that played out is Internet stock Groupon, Inc. (GRPN), which rocketed 175% from $2.60 in mid-November to its current level at $7.07 per share. The upward surge was driven by both new investors and major short covering. On March 28, prior to the major upward push, there were 41.7 million shares shorted on Groupon or 20.1% of the float. (Source: Yahoo! Finance, last accessed June 4, 2013.) As of May 15, shorts accounted for a mere 6.5% of the float.

While Tesla and Groupon were great short selling squeeze opportunities, there are other potential heavy short selling squeeze candidates that could be set to pop, based on their short positions as of May 15.

Some stocks currently being kicked about by traders include: Vera Bradley, Inc. (VRA), at 72.5% of float; Uni-Pixel, Inc. (UNXL), 43.2% of float; Pitney Bowes Inc. (PBI), 38.1% of float; First Solar, Inc. (FSLR), 35.8% of float; and GameStop Corp. (GME), at 34.9% of float.