Betting Against the Street's Bears

Dylan Wetherill is the founder of ShortSqueeze.com, which provides short-selling data and analysis to investors.

Short sellers bet on stock prices going down by selling borrowed shares, hoping to replace them later at a lower price. Explain what a short squeeze is.

A short squeeze happens when a large number of a company's shares are sold short and the stock starts to go up. Then you've got short sellers looking to buy the stock back, and that can send the share price up a lot over a short time. You're dealing with stored energy in a stock. When you short it, it has to be bought back eventually -- about the only example in the stock market when buying has to set in.

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Isn't it dangerous to bet against the shorts?

We've found that these sophisticated traders can be used as predictors. We're not talking about your neighbor with a long-term perspective. If a stock with a lot of short selling starts to break out, these money managers start buying -- that's their exit strategy.

Which stocks make the best short-squeeze candidates?

You need high levels of short interest in a stock with newfound strength. Look at short interest in relation to average daily trading volume, expressed as the number of days it would take to cover all the short positions in a stock -- that's your stored energy. Then you look for a trigger. It could be anything: a stock that trades above its average price measured over a rolling 200-day period or a stock that breaks into a 52-week high, or a company that announces some other good news. You have to act fast -- often the window is only one day to one week.

Are you watching any squeeze candidates now?

One is Amedisys Inc. (AMED), a home health-care provider. It trades near a 52-week high, yet it would take 15 days of buying to cover the short interest. Myriad Genetics (MYGN) is near a high as well, with six days to cover.

Can short interest tell you anything about the health of the stock market overall?

You know the expression, "The stock market climbs a wall of worry"? Short interest is part of that wall. In 1999 and 2000, short selling was at record lows while the market was at its peak. Right now, we have a tremendous amount of short selling. We think we're at the bottom.

Anne Kates Smith brings Wall Street to Main Street, with decades of experience covering investments and personal finance for real people trying to navigate fast-changing markets, preserve financial security or plan for the future. She oversees the magazine's investing coverage, authors Kiplinger’s biannual stock-market outlooks and writes the "Your Mind and Your Money" column, a take on behavioral finance and how investors can get out of their own way. Smith began her journalism career as a writer and columnist for USA Today. Prior to joining Kiplinger, she was a senior editor at U.S. News & World Report and a contributing columnist for TheStreet. Smith is a graduate of St. John's College in Annapolis, Md., the third-oldest college in America.