How Do GameStop-Style Short Squeezes Work Out For Retail Investors In The Long Run?

The pandemic created a lot of “firsts” in our world and it created many in the investment world in particular. For one, the usage and discussion of the term “short squeeze” became an everyday word. 

Before the GameStop short squeeze driven by retail traders, the term was commonplace in the investment world and buried some in stock market textbooks or trader education material. The term became popular in early 2021 when the stock market was in the midst of a strong rebound from the March 2020 COVID-19 low.

New investors who came into the market during the pandemic — what else was there to do? — and fueled by the media were enticed into making a fortune in the “meme” stocks.

It should be noted that many did make good money, but unfortunately many did not. The most popular stocks were GameStop Corp. GME, AMC Entertainment Holdings Inc AMC and Bed Bath and Beyond Inc BBBY.

Unfortunately, many investors are still touting this as a solid investment strategy. The strategy: buying stocks with an extremely high short interest and profiting when the investors who are short the issues are forced to cover.

On Friday’s PreMarket Prep show, co-host Dennis Dick examined the long-term price patterns of several stocks with high short interest and their corresponding price action over the last few years.

What Is A Short Squeeze? A short squeeze occurs when many investors believe that an issue is overvalued and wager against the issue — and its price moves higher instead. A short squeeze can instigate wild spikes and extremely volatile trading in a stock's price as short sellers attempt to limit their losses.

The new wave of investors are trying to anticipate a short squeeze by buying stocks that demonstrate a strong short interest.

What Is Short Interest? Short interest is the number of shares that have been sold with the anticipation of buying back at a lower price. The short seller will need to borrow shares and sell these borrowed shares to buyers willing to pay the market price. It should be noted all issues borrowed will have a corresponding interest rate that accrues daily and will need to be paid back when the issue is returned.

Short interest is often expressed as a number or percentage. FINRA requires firms to report short interest positions in all customer and proprietary accounts in all equity securities twice a month.

Why High Short Interest? Although some of the media and investors treat short sellers as villains, they serve a useful purpose in the markets. In other words, companies that are poorly run and unprofitable should not be rewarded with a skyrocketing share price.

Dick illustrated his point by referring to a popular website, www.highshortinterest.com. From looking at the top holdings, it is evident that the short sellers have generally been correct in the long run.

When asked Friday about the harmful and predatory aspect of short selling, Dick did not hold back.

“It is not the short sellers that make the stocks go, it's bad management,” he said. “The people that are using www.highshortinterest.com for trading ideas are doing it backward.”

As the list was pulled up, he emphasized that most of the stocks on the list are “terrible companies that are struggling and have been the worst performers.”

He warned investors that “if you are trying to make money off a short squeeze, you have to realize that the companies are going down 90%-95% of the time.”

Moving Forward: The primary goal of the PreMarket Prep Show is to help traders and investors navigate these treacherous markets. The main point of Dick’s segment was that investors should not rely on this unreliable trading strategy.

As far as shorting issues, investors must define their own risk parameters and decide whether or not it fits in with long-term investing goals and objectives.

The segment from Friday’s show on high short interest stocks can be found here:

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