The flying TSLA is here! Elon Musk hasn’t (yet) produced a flying car, but he has created a flying stock. TSLA jumped over $129, or nearly twenty percent, yesterday and at the time of writing is up another $100 in this morning’s pre-market, taking it close to $900. The trigger for the jump came last week, when Tesla reported earnings of $2.14, handily beating consensus estimates of around $1.81. Obviously, though that doesn’t explain a move of over 55% from the close that day in less than four trading days, and the real reason contains some interesting lessons for investors.
What we are seeing is a classic short squeeze that began a while back. In May of last year, when the headlines were dominated by an analysts’ bear case of TSLA at $10, I wrote that the more likely scenario was that the shorts, at that time representing around 30% of the outstanding stock, would get squeezed. That started shortly after.
As of January 15, around 25 million shares of TSLA, just under 14% of the outstanding shares, were held short. Once upward momentum begins there is a rush to exit those positions. If you are a holder of the stock though, why would you let the shorts get out cheaply? It makes far more sense to hold on, so supply for those desperate buyers is limited. What you see in the chart is the inevitable result of large, panicked demand and limited supply.
Yesterday’s move alone would have cost those short sellers an estimated $2.5 billion, bringing total loses for short positions in the stock this year to just over $8.3 billion. And that is without this morning’s move.
The obvious lesson there is that shorting a stock, any stock, is dangerous.
In these days of app based, commission-free trading, everybody is a trader, or at least thinks they are. For some, trading like a trader means taking short as well as long positions, but based on conversations I have had, many of those people don’t really get the risk.
The problem is that possible losses on a short position are unlimited. If you buy a stock, the most you can ever lose is what you put into the position should the stock go to zero. If, however, you short a stock at say $25 and it goes to $275, you have lost 10x your initial position, and that is without the effects of leverage. Obviously, that is an extreme example and not that likely, nor is it quite that simple as in most cases margins would be called or positions forcibly closed, but you get the idea.
Short selling should only be done within the framework of a tight, strict plan to cut losses should the trade not work out. That is so important because of the second thing that the TSLA chart shouts out:
Momentum is a powerful thing.
When I worked in a dealing room, we used to joke that traders were basically the highest paid sheep in the land. It was quite possible to not just survive, but to make a lot of money, without ever having an original thought. All you had to do was follow a market trend for a while and be disciplined about taking a profit at the first sign of reversal.
The trading stories that most people hear about are the heroic, contrarian stands, such as in The Big Short, but regular momentum trades are what fund those kinds of things and are much more common. Put simply, once a move starts, there are an awful lot of people looking to jump on the bandwagon. It might not be a bad idea for you to consider it too if you are looking for a quick profit.
That, however, is not investing. If you are looking to do that, you have to pay attention to the other lesson from TSLA’s meteoric rise.
First and foremost, product matters.
Tesla has had its problems over the years, but underneath it all, and the reason I have remained bullish on the stock for a couple of years, is that the cars themselves are great and extremely popular. As frustrating as it was at times to see the continued push for growth over profit, it turns out it was the right thing to do. Lack of demand was never a problem and investing in an attempt to meet it now looks very smart.
After a move like this, a retracement in TSLA will almost certainly come before too long. When it does, I am sure you will once again hear a chorus of naysayers telling us that the end is nigh. My advice then will be the same as it was following negative headlines in September, have faith and buy the dips!
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.