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Sneak Preview: A Selling Formula
8. Hype plus massive short interest equals sell. Whenever you see a stock that's heavily hyped, and also heavily shorted, you should sell. Hype is a combination of analyst recommendations, celebrity endorsements, and much-praised facts about a company that don't necessarily have anything to do with making money.
Back in the late 1990s and in 2000, Internet stocks traded off of hype — people bought them based on the number of page clicks or unique new visitors, not on earnings or revenues. Eventually all these stocks crashed and burned; that's how hype works as a great contrary indicator.
If short interest is high — and I regard anything over 10 percent as high, and anything over 20 percent as astronomical — you could be set up for either a short squeeze or a big decline. If there's high short interest and the shorts are wrong, you get a short squeeze. (A short squeeze happens when a stock that the shorts expected to decline instead goes up and the shorts decide to cut their losses. In order to do that, they have to buy the stock to cover their short positions. That causes the price of the stock to go even higher.)
But when the shorts are right, you see the stock fall. I'd say that the shorts are right about as often as they're wrong. But when the analysts all love a stock that the shorts hate, it's much more likely that the shorts will be right and the stock will go lower.
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At the time of publication, Cramer was long Yahoo!.
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