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3 Short-Squeeze Stocks Ready to Rally

By: StreetAuthority
Posted: 12/5/2012 2:00:00 PM
Referenced Stocks: CHT;RY;TRI

One of the quickest and easiest ways to make gains in the stockmarket is to own a stock that's experiencing ashort 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 powersshares 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 toprofit .

When investigating potential short squeeze candidates, you can check a stock'swill 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 thecatalyst 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 smallestbullish event could send these stocks soaring...

1. Royal Bank of Canada ( 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 strongbalance 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 ( 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 freecash 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 simplemoving 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.