Hedge Funds Are Trapped Again | 3 Potential Short Squeeze Stocks

The short squeeze is one of the scariest things that can happen to a hedge fund. It’s also one of the most profitable opportunities for regular investors.

Most people think of the GameStop saga in 2020 as a one-off event—a lightning strike that won’t hit twice. They watched a stock soar 9,800% in a couple of months, turning a simple $5,000 investment into nearly half a million dollars, and assumed it was a fluke.

They’re wrong.

Short squeezes happen all the time. They may not all deliver 100-fold returns, but moves of 300% to 500% are quite common.

Right now, I’m tracking three specific stocks setting up for a potential short squeeze. These companies have that perfect combination: a lot of shares sold short and a stock price that keeps making new highs.

When hedge funds get trapped in these trades, they don’t just lose money. They provide the fuel that sends your investment into the stratosphere.

The Mathematics of Infinite Risk

To understand why these trades explode, you have to understand the terrifying math facing the short seller.

A lot of people don’t realize you can make money when stocks go down. In a standard short sale, you borrow an asset—let’s say rare coins, as billionaire hedge fund manager Bill Ackman has explained—and sell them at the current market price of $1,000.

You wait for the value to drop. If the price falls to $500, you buy the coins back, return them to the lender, and pocket the $500 difference.

That’s when it works. But what happens when it doesn’t work?

When you buy a stock, the most you can lose is your initial investment. The stock can only go to zero. But when you short a stock, the price can go infinitely higher. You can lose three, four, or five hundred times your initial investment.

The GameStop Case Study

In 2020, the hedge fund Melvin Capital shorted 50 million shares of GameStop at around a dollar a share. They were betting the company would declare bankruptcy and go to zero, which was the general consensus at the time.

A bunch of retail investors on Reddit’s Wall Street Bets board devised a plan. If they pooled their money and all bought the stock, they could drive it higher. If the stock rose from $1 to $2, Melvin Capital would lose $50 million.

They pushed it all the way to $5. The hedge fund’s $50 million short bet quickly turned into a $200 million loss.

This is where the mechanics of the squeeze take over. In a traditional stock investment, you buy to enter and sell to exit. With a short, you sell to enter and buy to exit.

To cut their losses, Melvin Capital would have to buy. This would add more fuel to the fire, bring even more buying volume, and send the stock higher. Instead, they doubled down. They kept selling while the public kept buying. Their hubris eventually cost them a $2 billion loss.

That’s the power of a short squeeze. It’s why selling short is risky.

Potential Short Squeezes Happening Right Now

It doesn’t always work out this way. Most stocks being sold short are terrible stocks. There is a reason hedge funds are betting against them. Groupon, for example, has a 44% short interest. I didn’t even know they still existed.

But every once in a while, these funds get it wrong. When they do, Wall Street loses, and savvy retail investors can hit it big.

Take Lulu’s Fashion Lounge (Ticker: LVLU).

Last month, the stock’s short interest—the percentage of its shares being held short—hit 42%. Investors were betting big that this stock was a dog.

On January 12th, that all changed. News broke that the investment firm Freedelland Enterprises had taken a 5% stake in the company and was working to turn it around. Investors piled in.

At the same time, short sellers ran for the exits.

This wasn’t magic. It was a mechanical unwinding of a trapped position.

Where NOT to Look: The AI Trap

Before we get to the opportunities, you need to know where this strategy will fail.

Right now, big software stocks are getting hammered. Hedge funds are beginning to short them, but in this case, I think it’s for good reason.

We’re witnessing the first real-world effects of AI. Artificial intelligence is looking at the software as a service business model and saying it can do this cheaper, faster, and without lunch breaks.

Last month, Anthropic released an upgrade to its AI model, Claude. Claude gained industry-specific plugins and the ability to coordinate teams of autonomous AI agents.

The market is asking a simple question: Why pay $50,000 a year for enterprise software when a $20 a month AI assistant can do most of the work?

The response has been full-on panic.

 

Microsoft lost more than a quarter of its value. Oracle got obliterated. While the S&P 500 sits within 1% of all-time highs, the software sector has collapsed.

 

The market has priced in perfection for the tech sector, and a lot of these companies need to be brought down to reality. So hedge funds are betting against them at record levels.

This is not a good place to look for short squeezes. Plus, these are hundred-billion-dollar companies. It would take an enormous amount of capital to punish these short sellers in any meaningful way.

The Squeeze Formula

To find a potential short squeeze candidate, I look for three specific criteria:

• Small to medium-sized companies
• Small floats — all things being equal, the fewer outstanding shares a company has, the more effective a short squeeze is going to be
• High short interest combined with a stock price near its highs

When a stock is heavily shorted but keeps making new highs, the bears can’t take the pain forever. Eventually, they abandon their cause, and the stock rises even further.

Here are three stocks that fit this short squeze set up perfectly.

1. Solaris Energy Infrastructure (SEI)

Solaris provides industrial-grade, rapidly deployable power generation. Their biggest clients are data centers.

As these data centers continue to put a strain on the local power grid, Solaris offers a quick solution to keep them running. They are perfectly positioned for the AI energy bottleneck.

The price action tells the story:

 

Despite this incredible performance, the bears cannot take the pain forever. As they abandon their cause, expect the stock to rise even further.

2. TeraWulf (WULF)

TeraWulf develops, owns, and operates vertically integrated, environmentally sustainable data centers designed specifically for high-performance computing.

That’s their fancy way of saying they mine Bitcoin.

This is a bit of a controversial pick given Bitcoin’s 50% decline over the last four months, but TeraWulf stock has been almost completely unaffected. In fact, it just made a new multi-year high.

I actually predicted this decline in Bitcoin a few months ago, and this is a pretty rational place for Bitcoin to bounce. If it starts to rally from here, it will add even more buying pressure to the stock and trigger a powerful short squeeze higher.

The company reports earnings on the 26th, which could be the catalyst that starts that move.

3. Tango Therapeutics (TNGX)

I’ll be honest—I know absolutely nothing about biotech. But I know how to read a stock chart, and this one is going straight up.

With more than half of the available shares held short, this thing could unwind in record fashion. Biotechs move fast, so keep this one on your watchlist and look to buy on any meaningful move higher.

Follow the Data

You can track this data yourself. Stockanalysis.com has a most shorted stocks list. There are other sites like highshortinterest.com.

But remember the rule: high short interest alone isn’t enough. You need to see the stock price holding up or making new highs. That’s the signal that the short sellers are wrong and are about to be forced to buy.

When hedge funds get it wrong, Wall Street loses, and savvy retail investors can hit it big.