While listening to CNBC Wednesday, I heard an interesting comment.
An analyst was talking about how this market needed a correction because investors were too bullish – which is a message we talk about weekly.
While filling his argument in, he mentioned that short interest is at the lowest levels we’ve seen in years. If true, it would mean that there are fewer opportunities to benefit from one of my favorite single-stock indicators, the Short Squeeze Index.
My Short Squeeze Index is a rating or number for each of around 1,800 companies that tips me off when a stock may be getting ready to make a parabolic move.
Example: Shares of Celsius Holdings (CELH) went into their earnings with a 92% reading of the Short Squeeze Index. The company beat estimates and then rallied more than 30% as the positive results triggered a short squeeze rally.
Let’s take a moment to go through “why” short squeezes work.
Everyone remembers the Gamestop (GME) story from a few years ago. That’s an extremely rare example of a short squeeze, but there are hundreds of these situations that play out every month on stocks that don’t get as much attention.
Shorting stock can be a dangerous undertaking.
You’re betting that the stock will decline and using margin accounts to do it, which means that you’re leveraged. If the stock goes down, the shorts are happy, and they pocket their profits. It’s a totally different story when a stock goes up though. When this happens, the short sellers start feeling the pain as their leveraged losses start to add up quickly. At some point, they have to call it quits and cover their positions to limit losses.
When a whole bunch of bearish pros on a particular stock starts to cover all at once – meaning they’re elbowing one another and stampeding through the narrowest of doorways and grabbing shares at every and any price – that stock can go parabolic.
That’s a “short squeeze.”
Of course, you must know that the potential for a squeeze is there if you want to benefit from the situation.
Enter Carmax (KMX)
This has been one of the consumer stocks that I have shied away from over the last year. The reason is simple… my rule is that you avoid companies that require a loan to purchase their products when interest rates are high.
Simple, right?
Well, the consumer is now finding that they can’t wait to buy or replace their vehicles, so Carmax and a few other retailers are benefiting from the return of the buyer.
Carvana (CVNA) found itself in a similar situation, and guess what? Their stock soared on a short squeeze rally last week. I wrote about it here.
As it stands now, short sellers have been busy betting against Carmax. Currently, 18,200,000 of Carmax’s shares have been shorted by bearish traders. That’s nine times the daily average of the stock and 12% of the stock’s float.
From a technical perspective, Carmax shares are trading in a bullish trend. The stock’s 50-day moving average is trending higher AND getting ready to cross above the 200-day moving average.
That cross would form what we technical analysts call a Golden Cross. It suggests that the stock’s positive momentum is growing stronger after a period of volatility.
My Short Squeeze Index for Carmax is currently at 91% and rising, indicating that a squeeze rally is likely to be triggered soon.
We all know the psychological importance of round numbers. With $80 just overhead on Carmax’s price, my forecast is that the short squeeze rally will be triggered when the stock crosses $80. This is where the bears will start to close their losing bets by buying the stock to cover their positions, thus accelerating the price higher.
Bottom Line
I’m expecting a short squeeze rally to be triggered as KMX shares cross above $80. From there, the stock is likely to continue to my first price target of $85 followed by a second, slower move to $88.
Have fun watching the rally develop and don’t worry, I’ve got a list of these for us to talk about in the future.
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About the Author
Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.