There's one huge risk in investing on the short side of a heavily-shorted stock. If short sellers are forced to cover their positions by buying back borrowed
shares, then they unwittingly help spur a buying frenzy, pushing a stock up quickly. With the
market steadily rebounding, that's precisely what's been happening, as the shorts' favorite targets are some of the biggest gainers of 2012.
Paradoxically, that makes this a great time initiate a fresh short position in these very same stocks. Short sellers already pointed the way to problematic business models, and at higher prices than when they were initially targeted, they could easily be even more
overvalued now.
Short sellers are likely to retarget these names when they are done licking their bloody paws, but you have a chance to go short in these stocks before them.
Even if you don't tend to be a short seller, the
short squeeze should at least compel you to take profits if you are hold these stocks in a long position. They've been pushed up by exogenous factors and are likely to fall back once the current rally peters out.
The stocks below have all risen at least 30% in just the first seven weeks of 2011...
Unwarranted rising confidence in BofAThe sharp rebound in&
David Sterman
David Sterman has worked as an investment analyst for nearly two decades. He is currently an analyst for
StreetAuthority.com