DELAFIELD, Wis. (Stockpickr) -- Short-sellers hate being caught short a stock that reports a blowout quarter. When this happens, we often see a tradable short squeeze develop as the bears rush to cover their positions to avoid big losses. Even the best short-sellers know that it's never a great idea to stay short once a bullish earnings report sparks a big short-covering rally.
This is why I scan the market for heavily shorted stocks that are about to report earnings. You only need to find a few of these stocks in a year to help enhance your portfolio returns -- the gains become so outsized in such a short time frame 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 off a short squeeze. This way, you're letting the trend emerge after the market has digested all of the news.
Of course, sometimes the stock is going to be in such high demand that you risk missing a lot of the move by waiting. That's why it can be worth betting prior to the report -- but only if the stock is acting technically very bullish and you have a very strong conviction that it is going to rip higher. Just remember that even when you have that conviction and have done your due diligence, the stock can still get hammered if The Street doesn't like the numbers or guidance.
If you do decide to bet ahead of a quarter, then you might want to use options to limit your capital exposure. Heavily shorted stocks are usually the names that make the biggest post-earnings moves and have the most volatility. I personally prefer to wait until all the earnings-related news is out for a heavily shorted stock and then jump in and trade the prevailing trend.
With that in mind, here's a look at several stocks that could experience big short squeezes when they report earnings this week.
My first earnings short-squeeze play is electric car maker Tesla Motors (TSLA), which is set to release numbers on Wednesday after the market close. Wall Street analysts, on average, expect Tesla Motors to report revenue of $669.98 million on earnings of 20 cents per share.
Just this morning, R.W. Baird raised its price target on shares of Tesla Motors to $215 per share from $187 per share and reiterated its strong buy rating on the stock.
The current short interest as a percentage of the float for Tesla Motors is extremely high at 35.2%. That means that out of the 83.87 million shares in the tradable float, 29.64 million shares are sold short by the bears. If the bulls get the earnings news they're looking for, then shares of TSLA could easily explode sharply higher post-earnings as the bears rush to cover some of their bets.
From a technical perspective, TSLA is currently trending above both its 50-day and 200-day moving averages, which is bullish. This stock has been uptrending strong for the last two months and change, with shares soaring higher from its low of $116.10 to its intraday high of $205.50 a share. During that uptrend, shares of TSLA have been making mostly higher lows and higher highs, which is bullish technical price action.
If you're bullish on TSLA, then I would wait until after its report and look for long-biased trades if this stock manages to break out above its new all-time high of $205.50 a share, or above Wednesday's high if greater with high volume. Look for volume on that move that hits near or above its three-month average action of 9.58 million shares. If that breakout hits, then TSLA will set up to enter new all-time-high territory, which is bullish technical price action. Some possible upside targets off that breakout are $240 to $250 a share.
I would simply avoid TSLA or look for short-biased trades if after earnings it fails to trigger that breakout and then drops back below some key near-term support levels at $190 to $180 a share with high volume. If we get that move, the TSLA will set up to re-test or possibly take out its next major support levels at its 50-day moving average of $163.26 to its 200-day moving average of $142.62 a share.