WINDERMERE, Fla. ( Stockpickr) -- News events have the power to create massive volatility in stocks, and the one event that can move them substantially higher or lower is an earnings release. Take that one step further and combine a bullish earnings report with a stock that's heavily shorted, and you have the fuel that can ignite a large short squeeze.
Short-sellers hate being caught short a stock that produces earnings that please the bulls on Wall Street. When this happens, tradable short squeezes often develop as the bears rush to cover their positions and avoid even bigger losses. Even the best short-sellers know that it's never a good idea to stay short once a big earnings-sparked short-covering rally starts.
This is precisely why I search the market for heavily shorted stocks that are about to report earnings. You only need to find a couple of these candidates in a year to help enhance your portfolio returns - the gains become so outsized in such a short timeframe that your profits add up quickly.
That said, let's not forget that stocks are heavily shorted for a reason, so you have to use trading discipline and sound money management when playing earnings short-squeeze candidates. It's important that you don't go betting the farm on these plays and that you manage your risk accordingly. Sometimes the best play is to wait for the stock to break out following the report before you jump in to profit from off a short squeeze. When you do this, you're letting the trend emerge after the market has digested all of the news.Related: 5 Earnings Stock Trades for Quick Gains That said, sometimes a stock will be in such high demand that you could miss a lot of the move. That's why it's only worth betting prior to the report if you have a very strong conviction that the stock is going to explode higher. Here's a look at a number of stocks that could experience big short squeezes when they report earnings this week.