Rebound stock detector

An Indicator That Can Help You Find Rebound Candidates

 Over the last few months I have extolled the value of looking at the sentiment toward a stock and how it can help you choose better investments. With the focus of this space being about stocks or markets that are ready to rebound, I wanted to dig a little deeper into one particular sentiment indicator to show you how I used it to make nearly a 30% profit in barely over a month, and how you can do the same!

Before we get to the rebound detector, did you know that buying stocks and betting on them to go up isn’t the only way to make money in the market? You can also bet against stocks you believe will fall by selling them short. Short selling means you are selling shares you don’t currently own at a certain price with the promise to buy it back later. When done correctly, you can buy the stock you shorted at a much lower price to earn big profits.

The indicator I want to focus on is the short-interest ratio. The short-interest ratio measures the number of shares sold short divided by the average daily trading volume of the stock. The volume is the amount of shares traded in a given time period.

For instance, if ABC Co. has two million shares sold short and the average daily trading volume is one million, the short-interest ratio is 2.0. Anything above 5.0 gets my attention and anything in double digits certainly peaks my interest.

Because we use the short-interest ratio as a contrarian indicator, having a high ratio is a good sign as these short sellers may have to become buyers as the stock rallies. However, just because a stock has a high short-interest ratio doesn’t mean you should buy it. You have to look at the whole picture.

To give you an idea, I put together the following table with 10 stocks, all of which have a double-digit short-interest ratio. To give you an idea of the wide range of stocks that can have a high ratio, I have included their price performance for the last six months and the current EPS rank from Investor’s Business Daily.

EPS is the earnings per share, so a rank of 75 means that a company’s profit growth is better than 75% of all publicly traded companies.

I arranged the stocks based on their performance over the last six months and I want to look at a couple of the stocks on the list. Let’s start with the name at the bottom of the list, Cliffs Natural Resources (NYSE: CLF).

We see from the table that the price of CLF is down 38.89% over the last six months. The short-interest ratio is at 11.7 and the company is right in the middle of all listed companies when it comes to their earnings performance over the last few years.

Looking at the chart for CLF we see the decline and the trend in the stock. The last time the stock was anywhere near the current price level was back in 2009 at the end of the bear market. Now we see a huge decline that is taking place as the market is hitting new highs. There is nothing about CLF that suggest it is ready to rebound.

Let’s turn our attention to the top name on the table above, Illumina (Nasdaq: ILMN). ILMN is up 66.48% over the last six months, the short-interest ratio is at 13.8 and the company is in the top 15% when it comes to their earnings performance over the last few years.

I recommended ILMN to the subscribers of my Value Hunter newsletter back on May 5, and I can tell you that the short-interest ratio has actually increased since the beginning of May. When I made the recommendation, the ratio was at 8.9.

Looking at the daily chart, we can see how the stock had hit a support level in the $128 range and it was close to being at an oversold level on the stochastic readings. The blue arrow denotes when the recommendation was made.

The weekly chart actually does a better job of showing the upward trend the stock has been in for the last year and a half. Yes, the stock slipped from the beginning of March through the middle of April, but that is what qualified it for a rebound. That decline also put the weekly stochastic readings at their lowest level since early 2013 which also made it attractive.

Since the recommendation, ILMN is up over 20% and was up as much as 28% before dipping last week.

The point is this: bearish sentiment alone is not enough to make the stock a good investment. In the case of CLF, the bearish sentiment is warranted due to the technical and fundamental performance over the last few years. In the case of ILMN, the bearish sentiment is acting as a driver to move the stock higher. These are the scenarios you want to look for: positive technical and fundamental performance with a certain amount of bearish sentiment.