You’ve probably seen some penny stocks go from $3 to over $10 in just a few trading sessions. Heck, you might’ve heard one of your friends who trade to tell you to get in near the top, and you may have lost some money. As always, you want to buy low and sell high, and short high and cover lower. If you’re looking to trade penny stocks, you need to understand a few intricacies that could move the stock. Now, short interest matters with penny stocks.
Penny stocks with a low float and high short interest are those poised to see these massive moves if there’s a positive catalyst. Moreover, when this happens it squeezes the shorts, forcing them to cover positions. That said, let’s take a look at how you could interpret short interest with penny stocks, thereafter, you should have a good understanding of why short interest matters with penny stocks.
Why Short Interest Matters With Penny Stocks
Before we get into the details behind why short interest matters with penny stocks, we need to define short interest, floating shares and short squeeze.
Short Interest, Floating Shares and Short Squeeze Defined
Short interest is the number of shares traders or investors sold short but didn’t cover yet. That said, short interest tends to be an indication of whether market participants are bearish on the stock. However, a high short interest coupled with a positive catalyst could send a stock flying because some shorts may not be able to take the pain. In turn, this would cause them to cover and bid the prices up.
Floating shares, unlike shares outstanding, is the number of shares actually available for trading in the open market. That said, if a stock has a low number of floating shares with a high short interest (or number of shares short / number of floating shares), there could be a high level of demand for shares if there’s positive news. When there’s positive news, low number of floating shares and high short interest, then a stock could be poised for a short squeeze.
Now, a short squeeze is simply when a stock increases in price quickly due to a lack of supply and high demand for the stock. When prices move fast, short sellers cover their position, further driving the stock higher.
Short Interest Matters With Penny Stocks
Now, if you want to scan for penny stocks with high short interest to potentially gain in a price rise or take part in a short squeeze, it’s not to hard to do that. You could use Finviz, which is a free tool, and you could filter for price and percentage of float that are short.
Although penny stocks are defined as those trading below $5, according to the U.S. Securities and Exchange Commission (SEC), I filtered for stocks trading under $7 here. Moreover, I filtered for those with a short interest percentage greater than 20%.
Short Interest Matters With Penny Stocks – Example
For example, this is exactly what I look for when trading penny stocks.
Here’s a look at a snippet of one of the emails I send out to the trading community.
“GEVO – Split & squeeze play above $4 for a move to $6. Such a dirty company, much like DRYS but the squeeze can be predictable here. Oversold so I doubt an offering is coming before some hype, so look for the run. Shares are heavily short so it could spike big. Now even if we do not trade this, because I probably won’t, I want you to learn from it by tracking the events in the following weeks to month. Splits like this happen all the time and I get some of my biggest wins gaming this pattern, however, it is risky as some companies will simply raise without news leaving you holding a bag that will not bounce.
HMNY, AKER and VVUS are a few stocks under $1 I like. HMNY is oversold lotto play, my guess is they’ll split and squeeze the stock soon, same as GEVO just did. I’ll wait for the split to try for the squeeze most likely but may jump in sooner than that given how heavily short it is and priced for bankruptcy. AKER and VVUS are continuation patterns I could see moving 10-20% out of these patterns.”
If you just look at the one example I showed earlier, you could understand why short interest matters with penny stocks. Now, it may be difficult to spot when you’re first starting out. However, when you have a trading community to lean on, more eyes are focused on penny stocks with high short interest. In turn, you could take part in a short squeeze and be on the “right side” when there’s positive news and the stock is running higher.
Jason Bond runs JasonBondPicks.com and is a swing trader of small-cap stocks.