Beneath all the good headlines, stocks are showing some worrying signs. There’s a significant reality gap between which stocks should be currently moving up, and which ones are actually doing so…
Riskier stocks are starting to move faster than the markets.
That’s a tell-tale sign that we’re due for a short-term pullback.
Don’t get me wrong. 2020 is going to be a good year for markets.
But in the short-term, we’re about to see an end to the Santa Claus rally. That’s going to mean a correction to some very popular stocks.
Traders who got sucked in to the hype stand to lose a lot of money.
But don’t worry – there’s actually a way to play this to our advantage…
Risky Stocks and Hype are Leaving Traders in the Red
It’s been a good week for markets. The Dow, S&P 500, and Nasdaq all hit record highs on Thursday morning. The day before, President Trump and China’s Vice-Premier Liu He signed the “Phase One” trade deal between the two countries.
But this deal was largely accepted without much market movement as most of it was already priced in by traders. Meanwhile, earnings season kicked off this week, and there’s been a few stinkers.
Among the big banks that set the tone for earnings, Bank of America Corp. (BAC), The Goldman Sachs Group Inc. (GS), and Wells Fargo & Co. (WFC) all had mixed or disappointing earnings. JP Morgan (JPM) and Morgan Stanley (MS) both had strong earnings.
So the news right now is mixed, with some good and some bad.
And yet the markets are shooting up – and stocks meeting these two criteria are leading the charge:
First, it’s companies with a “low float.” The float of a stock is the number of shares that are available for trading. That’s usually very close to another number – shares outstanding – which is the total number of stock shares issued by the company. The difference is restricted shares – those not available for trade on the open market.
While there’s no hard and fast definition for “low float”, from a trading perspective I find that around 100 million or fewer tradeable shares is a useful rule of thumb.
When traders get interested in these low float stocks, supply can get tight quickly. That can send prices up higher than is justified, leading to short-term “mini-bubbles” in the stock.
For comparison, the many large cap stocks like the big tech stocks, all have floats in the billions. That means they are almost never affected by short-term supply crunches and it’s hard to move their stock price as easily as with low float stocks.
Another circumstance that can move a stock’s price quickly is a high level of short interest in a stock. That’s the percent of shares that are currently sold short, as part of bets that the stock will move lower.
When a stock that has a lot of short interest starts moving up, traders that were shorting it have to buy back shares to limit their losses. This added buying pressure makes the stock move up in price even faster, causing what’s called a “short squeeze.”
Put these two factors together in one stock, and you have a perfect recipe for explosive growth…
But not for long.
Once the short-sellers have covered their positions and the supply crunch of shares eases up, the stocks often fall just as fast as they rose – leaving traders that got in on the hype too late in the red.
We’re seeing this right now, for example with Virgin Galactic Holdings Inc. (SPCE). On no particular news, the private spaceflight company that has yet to launch a single paying passenger into space is up a whopping 74.09%:
Similarly, meat-substitute maker Beyond Meat Inc. (BYND) saw a huge spike in its share price on in the last two weeks:
Meanwhile, cosmetics retailer Ulta Beauty Inc. (ULTA) is up more than 5% in the last five days:
And while Tesla Inc. (TSLA) technically has a higher float than 100m at 142m, it’s still far short of General Motor Co.’s (GM) float of 1.3 billion or Ford Motor Co.’s (F) at 3.9 billion.
And even as it’s started to lose steam recently, it’s up more than 40% in a month:
This is what happens when there isn’t enough news to trade on, and investors start looking for higher returns from riskier stocks.
Again, I’m no bear. I see the market going up in the medium term.
But all this risk-seeking in low float, high interest stocks is about to break down. As I write this on Thursday, Tesla is already down -10% from its Tuesday high.
But don’t worry. There are two things you can do…
Here’s How to Get in Before the Hype
First, make sure you don’t get sucked in to the hype. Tesla is a good example, here. By the time everyone was talking about how great it was doing early in the week, it was already too late.
Or take Rite Aid Corp. (RAD). On the back of a good news report, the stock jumped from $7.52 on December 17th to almost $23.88 on December 27th.
But by January 7, it was down to $12, where it’s been stuck since:
In other words, these low float, high short interest stocks move up fast. But they fall just as fast too. That leaves traders who got in when the hype and share price were at their highest were stuck holding the bag.
Instead of getting in too late, ignore the hype – and look for stocks that are just beginning to break in either direction. For example, look at Whiting Petroleum Corp. (WLL). Two weeks ago, I told 10-Minute Millionaire readers to short the stock.
It was trading at $8.50 when I wrote the piece and anyone could have gotten in above $8.00 the day after the article came out.
Today, it’s at $6.32:
That’s a 21.29% profit. Meanwhile, the news is only now catching up.
If you took this trade, please let me know how you did in the comments below. I love hearing from you.
For another example, traders in my BetaFlow test run recently had the opportunity to score 100% on Wayfair Inc. (W), as it was making a break.
These are just some of the opportunities we’re about to see in the next few weeks, even as markets temporarily top out.
To sign up to receive the latest news and updates on the full launch of my newest trading service - and see how you can get more of these trades as I spot them – click here.
Great Trading and God Bless You,
D.R. Barton, Jr.