WINDERMERE, Fla. (Stockpickr) -- News events have the power to create big 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. Now, all of a sudden you have the fuel that can ignite a large short squeeze in any equity.
Short-sellers hate being caught short a stock that announces bullish earning and forward guidance. When this happen, we often see a tradable short-squeeze develop as the bear rush to cover their positions and avoid huge losses. Even the most skilled short-sellers know that it's never a great idea to stay short once a big short-covering rally starts that's sparked by an earnings event.
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 but 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 Small-Caps at Risk From Earnings Reports However, sometimes the stock is going to be in such high demand that you will 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.
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