) -- When emotion and investing converge, it can create some profitable opportunities. A perfect example comes from the stocks that "everyone" hates.
Investors hate stocks for different reasons. Maybe they lost money trading that ticker in the past; maybe they hate the company's products; maybe they hated working there. Regardless of what fuels it, hate is a powerful emotion in the markets -- most often because it's misplaced -- and not surprisingly, we have a way of gauging it.
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When I say that investors "hate" a stock, I'm talking about its short interest. A stock with a high level of shorting indicates that there are a lot of people willing to bet on a decline in its share price -- and not many willing to buy. But my research shows that that's historically been a pretty good gain indicator.
Going back over the last decade, buying heavily shorted large- and mid-cap stocks (the top two quartiles of all shortable stocks by market capitalization) would have beaten the
by 9.28% each and every year. That's some material outperformance during a decade when decent returns were very hard to come by.
It's worth noting, though, that market cap matters a lot -- short sellers tend to be right about smaller names, with micro-caps delivering negative returns when the same method was used.
Today, we'll replicate the most lucrative side of this strategy with a look at five big-name stocks that short sellers are piled into right now. These stocks could be prime candidates for a short squeeze in 2013.
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In case you're not familiar with the term, a "short squeeze" is the buying frenzy that ensues when a heavily shorted stock starts to look attractive again to investors, causing share price to skyrocket. One of the best indicators of just how high a short-squeezed stock could go is the short interest ratio, which estimates the number of days it would take for short-sellers to cover their positions. The higher the short ratio, the higher the potential profits when the shorts get squeezed.
Naturally, these plays aren't without their blemishes -- there's a reason (economic or otherwise) that these stocks are hated. But for investors looking for exposure to a speculative play with a beefier risk/reward tradeoff, the data tells us that these could be powerful upside plays for the coming year.
Without further ado, here's a look at our list of
large-cap short squeeze opportunities
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