Several of this year's hottest stocks have something in common: Investors believe they are overvalued, and are betting that their share prices will soon fall.
Tesla (TSLA), Beyond Meat (BYND) and SmileDirectClub (SDC), for example, are all being heavily shorted. Here's what that means:
When investors short a stock, they borrow shares from a broker and quickly sell them.
The short seller hopes that the price will soon drop so they can repurchase the shares, return them to the lender and pocket the difference between the price they sold the stock at and the price at which they bought it back.
In other words, if you short sell a stock that's trading at $100 and the price drops to $80, your profit on the trade is $20.
The problem for short sellers is that heavily shorted stocks tend to rise sharply on even a tidbit of good news, so investors betting against the stock have to move fast to avoid huge losses. That's known as a short squeeze, and it can push a price even higher.
This seems to be a factor behind the spectacular rise in 2020's momentum stocks.
Tesla shares are up more than 40% already this month, and on Wednesday reported fourth quarter sales and earnings that topped forecasts, sending its stock even higher.
Plant-based food maker Beyond Meat has soared 50%. And unprofitable braces seller SmileDirectClub, which plummeted after it went public last year, is up nearly 60% so far this year.
A fairly high percentage of these companies' available shares are being held by short sellers, according to data from the New York Stock Exchange and Nasdaq.
Get Ready For A Squeeze?
Peloton (PTON), Richard Branson's Virgin Galactic (SPCE), Tinder owner Match (MTCH) and outlet mall owner Tanger (SKT) are also big targets of short sellers, says Ihor Dusaniwsky, managing director of predictive analytics at S3 Partners, a research firm that focuses on short selling.
Hype about legal cannabis in Canada and several American states has led to heightened volatility for the shares of many marijuana producers. Most of the companies are not profitable, but investors have high hopes for the sector.
Dusaniwsky told CNN Business that Cronos (CRON), Canopy Growth (CGC), Aurora Cannabis (ACB) and Tilray (TLRY) all have above average percentages of their shares being held short. That could make them good candidates to be squeezed higher.
Betting against stocks has been a risky and mostly losing proposition lately. Short squeezes have been common in the past year, a time that has seen the S&P 500 shoot up nearly 25% and the Nasdaq soar more than 30%.
"Whenever you see the market go sharply higher, people have to reconsider their short positions," said Jason Brady, CEO of Thornburg Investment Management.
Brady said that seems to be the case with Tesla, a polarizing stock that has more bears betting against it than bulls who are firm believers in Elon Musk. Of the 34 Wall Street analysts that cover Tesla, nine have buy ratings, 10 rate it a hold and 15 recommend that investors sell the stock.
Thornburg runs a long/short mutual fund that owns stocks the firm thinks will go higher and ones it believes will go down. It does not have a position in Tesla.
Brady said many investors are reluctant to make a big bet in either direction on volatile stocks such as Tesla until after they report quarterly results.
Tesla's strong earnings show the dangers of betting against a heavily shorted stock. Good news can push the shares even higher.