3 Earnings Short-Squeeze Stock Trades

WINDERMERE, Florida (Stockpickr) -- I love to scan the market for stocks that have the potential for massive earnings short squeezes.

When a stock that is heavily shorted heading into its earnings report delivers a great set of numbers, it can see gigantic moves as the bears are forced to cover their positions. Of course, on the flip side, if the company disappoints, then the bears have a license to hammer the stock into oblivion.

That's why it's best to find a number of potential earnings short squeeze candidates and pick the names that are displaying the best price action on heavy volume going into their earnings calls.

What's even more helpful right now in squeezing the bears out of their short positions is that the S&P 500 and the Nasdaq are trading in pure breakout territory following the news that the Obama Administration has decided to extend the Bush-era tax cuts for two more years. This will put added pressure on the bears that are heavily short upcoming earnings plays to cover their bets since the overall market trend is growing stronger. This will really come into play on any heavily shorted earnings play that reports a bullish report that Wall Street likes.

The only major index that isn't in breakout territory is the Dow Jones Industrial Average. That index will enter breakout territory once it takes out 11,451.53. Once the Dow joins the party, then the bears will really be on the run and forced to think twice about shorting any stock that isn't in a clear downtrend.

There are a number of strategies that investors can use to play heavily shorted stocks heading into their earnings report. One way is to take a position ahead of the report if you think the company is going to report strong results. With this strategy, I would advise readers to look for stocks with heavy volume above the three-month average daily volume, which must be confirmed by bullish upside price action. If you don't see these characteristics, then I would wait for the report and see what transpires before placing your bets.

Traders can also wait for a company to report its numbers and for strength in the stock before jumping in to trade the momentum. There's nothing wrong with getting confirmation of the move first and missing some of the gap up just to make sure you're on the right side of the trade.

There's also nothing wrong with letting a stock come in first if it doesn't act right ahead of earnings and then taking a long position and playing the name for a reversal. Sometimes the shorts are right at first and the bulls then move in to squeeze them after a reasonable selloff. Apple(AAPL) is the perfect example of this after the stock sold off below $300 a share after its most recent earnings report. As you can see now, the stock has been punishing the bears and is setting up to break out above $321.30 a share.

Before we take a look at some potential earnings short-squeeze trades, let's do a bit of review. A short squeeze is a rapid increase in the price of a stock due to a lack of supply and an excess of demand. Short squeezes happen when bears who've sold a stock short are forced to cover their positions to avoid further losses as the stock rises.

Here's a look at a few stocks that could experience big short squeezes when they report earnings.