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 very bullish technically 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 enterprise cloud platform solutions provider Nutanix (NTNX) , which is set to release numbers on Tuesday after the market close. Wall Street analysts, on average, expect Nutanix to report revenue of $152.25 million on a loss of 44 cents per share.
The current short interest as a percentage of the float for Nutanix is extremely high at 92.8%. That means that out of the 4.99 million shares in the tradable float, 4.63 million shares are sold short by the bears. The bears have also been increasing their bets from the last reporting period by 33.4%, or by about 1.15 million shares. If the bears get caught pressing their bets into a bullish quarter, then this stock could easily rip sharply higher post-earnings as the bears move fast to cover some of their positions.
From a technical perspective, Nutanix is currently trending above its 20-day moving average, which is bullish. This stock has been uptrending over the last month, with shares moving higher off its low of $23.11 a share to its recent high of $34.96 a share. During that uptrend, shares of Nutanix have been making mostly higher lows and higher highs, which is bullish technical price action. That move has now pushed this stock within range of triggering a near-term breakout trade post-earnings above some key overhead resistance levels.
If you're bullish on Nutanix, then I would wait until after its report and look for long-biased trades if this stock manages to break out above some near-term overhead resistance levels at $34.96 to $35.90 a share with high volume. Look for volume on that move that hits near or above its three-month average action of 3.93 million shares. If that breakout triggers post-earnings, then this stock will set up to retest or possibly take out its next major overhead resistance levels at $39.90 to around $44, or even its all-time high of $46.78 a share.
I would simply avoid Nutanix or look for short-biased trades if after earnings it fails to trigger that breakout and then drops back below some near-term support levels at $32 to its 20-day moving average of $29.18 a share with high volume. If we get that move, then this stock will set up to retest or possibly take out its next major support levels at $26 to $23 a share.