David Sterman

It's always intriguing to look at the list of the most heavily-shorted stocks. Many investors like to see which companies are expected to tumble by various short-interest gauges. Owning these stocks long-term can give pause, and perhaps a reason to sell if short sellers' arguments appear to be on the mark. Other investors use the list of the most heavily-shorted stocks to find short candidates themselves. And that's a huge mistake. That's because the most-heavily shorted stocks are often the biggest gainers when major events come to pass.

We've seen this phenomenon again in recent days. On Tuesday morning, April 10, distressed grocery chain Supervalu (NYSE: SVU) weighed-in with quarterly results. They were pretty bad, but perhaps not as bad as the most aggressive short-sellers assumed. These short sellers had been holding 73 million shares in short accounts, making this the fourth most-shorted stock on the New York Stock Exchange. That short interest equated to an eye-popping 14 days' worth of trading volume.

Simply delivering bad but not horrible earnings led investors to embark on massive short-covering. By the end of trading on Thursday, shares had risen a hefty 23%. Some of that upward spike surely came from short-sellers covering their position by buying back borrowed stock. Roughly 10 million shares traded hands daily going into the quarterly report, though that figure spiked to 38 million on the day results were released.

Later that day, Alcoa (NYSE: AA) weighed in with results that were better than analysts had forecasted. As the fifth most heavily-shorted stock on the market, it should come as no surprise that shares quickly zoomed higher and are now up nearly 10% in the last few trading sessions.

David Sterman

David Sterman has worked as an investment analyst for nearly two decades. He is currently an analyst for StreetAuthority.com

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