Wednesday, May 23, 2007

Squeezing Shorts With Money Flow: A Stock Picking Strategy

When pessimism is overdone, you can benefit from short squeezes. The idea here is that, when everyone seems to be bearish on a stock, there are few sellers left. Once buying comes into the stock, the effect is amplified by short sellers fleeing their positions.

Several services help traders find promising short squeeze plays. The Squeeze Shorts blog has gotten off to a nice start. The Short Squeeze site is devoted to scanning for stocks with high short positions that are trading near important pivot levels; that are long and short candidates; etc. A recent post to the excellent StockPickr site identified a number of stocks with high short interest that also display high insider buying: a potentially powerful combination.

I decided to add to StockPickr's criteria by tracking my money flow measure (adjusted relative dollar volume flow) for one of the high short interest stocks that also display solid insider buying. NutriSystem (NTRI) has a short interest ratio of 10 and insider buying of $2.6M, according to StockPickr. It has also been added as a holding by three professional money managers.

As we can see, NTRI stock (blue line) has been trading in a range since early 2006. Its 20-day adjusted relative dollar volume flow (pink line), however, has been above its 200 day moving average (above zero on the chart) since the February/March decline. Indeed, over the past 30 trading sessions, NTRI has displayed net dollar inflows on 21 occasions--18 of which were above the 200 day moving average.

By adding money flow to the criteria of insider buying and high short interest, we can refine the short squeeze stock selection process. The fact that pros are buying NTRI, that the stock is displaying above average dollar inflows, and that there is still a very heavy short position overhanging the stock leads me to surmise that the resolution of the extended trading range will be to the upside. A portfolio of such candidates would make for a worthy strategy.


Overview of Relative Dollar Volume Flow Indicator

Tracking the Dollar Volume Flows Among Stocks