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 Wall 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, let's take a look at several stocks that could experience big short squeezes when they report earnings this week.
My first earnings short-squeeze play is Veeva Systems (VEEV), which provides cloud-based software solutions for the life sciences industry and is set to release numbers on Thursday after the market close. Wall Street analysts, on average, expect Veeva Systems to report revenue of $87.91 million on earnings of 10 cents per share.
The current short interest as a percentage of the float for Veeva Systems is very high at 18%. That means that out of the 58.07 million shares in the tradable float, 10.49 million shares are sold short by the bears. This is a large short interest on a stock with a reasonably low tradable float. Any bullish earnings news could easily trigger a big short-squeeze for shares of VEEV post-earnings that forces the bears to cover some of their positions.
From a technical perspective, VEEV is currently trending above both its 50-day and 200-day moving averages, which is bullish. This stock broke out on Tuesday above some previous overhead resistance at around $28 a share with decent upside volume flows. This breakout could be signaling that shares of VEEV are setting up for a much larger move higher into a previous gap-down-day zone from March.
If you're bullish on VEEV, then I would wait until after its report and look for long-biased trades if this stock manages to break out above Tuesday's intraday high of $28.89 a share (or above Thursday's intraday high if greater) with high volume. Look for volume on that move that hits near or above its three-month average action of 1.36 million shares. If that breakout develops post-earnings, then shares of VEEV will set up to re-fill some of its previous gap-down-day zone from March that started at $33.10 a share. If that gap gets filled with volume, then VEEV could even tag $35 to $40 a share post-earnings.
I would simply avoid VEEV or look for short-biased trades if after earnings it fails to trigger that breakout and then drops back below its 50-day moving average of $26.81 a share with high volume. If we get that move, then VEEV will set up to re-test or possibly take out its next major support levels at $24.39 to $23.82 a share, or even $21.57 a share.
Another potential earnings short-squeeze play is integrated poultry processing player Sanderson Farms (SAFM), which is set to release numbers on Thursday before the market open. Wall Street analysts, on average, expect Sanderson Farms to report revenue $727.26 million on earnings of $3.32 per share.
The current short interest as a percentage of the float for Sanderson Farms is extremely high at 47.1%. That means that out of the 20.39 million shares in the tradable float, 9.61 million shares are sold short by the bears. This is a massive short interest on a stock with a very low tradable float. If the bulls get the earnings news they're looking for, then shares of SAFM could easily explode sharply higher post-earnings as the bears jump to cover some of their bets.
From a technical perspective, SAFM is currently trending above both its 50-day and 200-day moving averages, which is bullish. This stock has been uptrending a bit over the last month, with shares moving higher from its low of $74.25 to its recent high of $85 a share. During that uptrend, shares of SAFM have been making mostly higher lows and higher highs, which is bullish technical price action. That move has now pushed shares of SAFM within range of triggering a big breakout trade post-earnings.
If you're in the bull camp on SAFM, then I would wait until after its report and look for long-biased trades if this stock manages to break out above some key overhead resistance levels at $85 to $86.60 a share with high volume. Look for volume on that move that registers near or above its three-month average volume of 487,677 shares. If that breakout gets set off post-earnings, then SAFM will set up to re-test or possibly take out its next major overhead resistance levels $91 to $95 a share, or even $96 to $100 a share.
I would simply avoid SAFM 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 $82 to its 50-day moving average of $79.84 a share with high volume. If we get that move, then SAFM will set up to re-test or possibly take out its next major support levels at $74.25 to $69 a share.