John DVLast week saw the mother of all short squeezes. It highlighted the huge profits that can be made in a short period of time when the strategy works exactly right.

Before I get to that, a short squeeze happens when short sellers who are negative on a company’s prospects have heavily bet against a stock. They pile in with bearish bets hoping the stock craters at the first sign of bad news.

When the company instead releases good news, such as a positive earnings report, the short sellers run for cover and buy back some of their short position. This buying power forces the stock price up. To add insult to injury, fresh buyers usually come in and bid the stock even higher, which adds to the short sellers’ pain.

This is a strategy we actively use in Forensic Investor.

Two of our current positions are short squeezes. Last week, one of those stocks was up nearly 30% on the day of its earnings announcement. We sold half of this position yesterday for a tidy profit.

But the most violent short squeeze I have seen was in shares of Weight Watchers (NYSE: WTW) last week.

Everyone knows Weight Watchers. The company is well known for its weight management programs.

Recently though, earnings had been under pressure and the stock price got hammered. Trading at nearly $30 a year ago, shares dipped below $4 this summer.

Shorts piled in at the smell of blood. According to data from Yahoo!, nearly 75% of the float (shares available for trading) was short. I checked with a Wall Street loan desk and the cost to borrow the shares was 20% annualized. That’s nutty.

While the shorts were counting their paper profits and the stock price slid further toward oblivion, they didn’t count on Oprah Winfrey coming in and taking a $43.2 million stake in the company.

If there’s ever a game changer for a company, it’s Oprah Winfrey. She’s not just a Personality with a capital “P” – she’s one of the most powerful brands in the world. Tens of millions of people hang on her product endorsements to improve all aspects of their lives.

Not only did Oprah take a big position in the stock, she’s also promised to do joint marketing and branding projects. That’s nothing if not good news for a battered company. It has the potential to be a total game changer.

On that news, the stock shot up 131% last week! The day of the announcement led to a 105% gain.

I haven’t seen moves like that in major companies since the Internet Bubble. The stock went from $6.29 to nearly $20 in three days before settling in at $16.68.

This move buried a lot of short sellers. And it’s a great illustration of how much pain can be inflicted when shorts are wrong.

That’s why we focus on lower short interest stocks when we short in Forensic Investor – that is, stocks that don’t cost your grandmother’s armchair to borrow.

I want to find a losing company that’s not on everyone’s radar. Those who were shorting Weight Watchers at 20% interest were just begging for trouble.

But this is also a great illustration of the sometimes massive gains you can get on the right side of a short squeeze, and they’re not too hard to spot. Just watch what everyone else is doing and go the other way. It’s a strategy we’ll continue to use in Forensic Investor for months and years to come.

John Signature

John Del Vecchio
Editor, Forensic Investor

Is Your Portfolio Ready for What's Next?

Investing is no longer a set-it-and-forget-it affair. If you’re still using that outdated approach in today’s irrational markets, you’re setting yourself up for massive losses and a difficult retirement. There’s a much… Read More>>
John Del Vecchio
In 2007, John Del Vecchio managed a short only portfolio for Ranger Alternatives, L.P. which was later converted into the AdvisorShares Ranger Equity Bear ETF in 2011. Mr. Del Vecchio also launched an earnings quality index used for the Forensic Accounting ETF. He is the co-author of What's Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. Previously, he worked for renowned forensic accountant Dr. Howard Schilit, as well as short seller David Tice.