Given that the stock wasn't showing much traction for the bulls in the after-hours trading session on Tuesday, it looked like we might get a small rally on Wednesday, if anything.
Instead, the stock exploded higher and the violent rally cost short-sellers more than $1 billion in mark-to-market losses as the stock powered higher. Tesla had one of its best days in a long time -- and more gains for the stock could be on the way.
At last count, a little more than 30% of Tesla stock was sold short. That sets up a massive short squeeze possibility should Tesla continue higher. This reaction is something Stephen "Sarge" Guilfoyle prepared TheStreet readers about roughly one month ago. On Thursday, shares were adding to the gains, up 3% to almost $330 in early trading. However, those gains faded to up just 1%, around $322.50.
Tesla Short Squeeze
Here's why bears need to be careful: As Tesla stock price continues higher, shorts who won't (or can't) sit on giant unrealized losses will begin to stop-out. Investors tend to place these stop-loss orders at obvious junctions, like the 200-day moving average for instance or notable support/resistance levels.
For those who aren't aware, a short-squeeze can occur in stocks when short-sellers opt to cover their positions, which they do by buying the stock. If a trader is short 100 shares of Tesla for instance and the position hits its stop-loss, the buyer then has to go into the market and buy 100 shares to get back to flat. When there's a sudden shift in momentum, many shorts tend to cover around the same time buyers are stepping in to have a net long position.
That's why short-squeezes tend to act as gasoline on a fire, as there is a rush of buying occurring all at once.
In my eyes, getting above the $300 and $310 level was important for Tesla. For some short-sellers, that was likely one area where they had their stop-loss orders parked and so it was no surprise to see Tesla gain steam throughout Wednesday afternoon after it powered right through that level. With the 200-day moving average at $323, Tesla stock could continue to gain momentum if more shorts start to cover their position.
Of course, it's possible that the shorts hold steady and only a small amount of them cover their position. That could cause Tesla stock gains to slow and for the stock to stagnate if bulls simultaneously lose confidence about pushing it higher.
So where does that leave us?
Remember that with a drama-filled name like Tesla, you don't have to be long or short. You can simply observe from the sidelines. As for the stock price, I would watch to see how Tesla handles the 200-day moving average. Above that level and say, the $330 mark, it could gain some serious traction.
Below and maybe the bears can stave off a rally. Keep in mind that Tesla is aiming to produce 5,000 Model 3 units per week by early July. Should it do so, that could be one more catalyst to a higher stock price.
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