Posted June 06, 2022
By Zach Scheidt
A Short Squeeze Is NOT a Green Light to Buy Stocks
"As a dog returns to its vomit, so fools repeat their folly." - Proverbs 26:11
My apologies for the crude imagery, but it's important to understand the foolishness in the market right now.
Over the weekend, I noticed a lot of chatter from investors.
Message boards, blogs and social media lit up with traders excited about the market rebound. But their enthusiasm was completely overshadowed by the sheer stupidity of their arguments.
Today, I want to explain why following these traders could be hazardous to your wealth.
And of course, we'll continue our discussion of what you can do to grow and protect your wealth in this turbulent market.
The Folly of Speculative Tech Stocks
Browsing through the messages many traders posted, I didn't know whether to laugh or get angry. Maybe I've got a twisted sense of humor…
But there's nothing funny about the way many of these "influencers" are convincing innocent investors to go back to the same speculative stocks that caused so much pain over the last few months.
Of course, you know that we've been warning you for months now about the danger these stocks pose.
And we've been shifting our retirement capital into stocks of companies that sell real products and services — and generate real profits for investors.
Most of these speculative stocks just don't do that.
And even if they do turn a profit, you're often paying a much higher price compared to the amount of profit per share you're getting from these names.
But since many of these companies offer exciting technology, some investors want to get involved.
That's a big mistake!
Because as an investor, you are buying a business. Regardless of how exciting that business is, it's really not a good business if it doesn't turn a profit — especially in today's market.
Like a Dog Returns to Its Vomit...
Despite the losses and devastation these stocks have caused, many investors are now going back to these speculative names.
And at least for a short time, these stocks are trading higher.
If you've been watching some of these stocks trade higher over the last couple of weeks, you may think we missed out on a good opportunity.
But let's take a look at what's really going on here.
In many cases, shrewd traders have set up short positions (or bearish plays) on these speculative stocks.
These traders make money when the stocks trade lower, and they lose money when the stocks trade higher.
For stocks that are heavily shorted — meaning there are lots of bearish bets against these stocks — there's an age-old trick you can play.
A "short squeeze" is when buyers step in and intentionally drive the stock price higher.
This means traders who are short start to lose money. The only way they can protect against these losses is to buy out of their short position.
In other words, higher prices squeeze the shorts out of their positions. And short sellers buying drives stock prices higher — temporarily.
But as you and I know, this doesn't change a thing about the underlying tech companies. It certainly doesn't help their business start generating a profit.
And eventually, these stocks start trading lower again.
Investors who got caught up in the short squeeze — buying when shares started trading higher — get that sick feeling all over again.
Don't get caught in this vicious cycle!
It's Still a Bear Market for Speculative Tech Stocks
Despite the recent rebound, it’s still a treacherous time for speculative tech stocks.
You do not want to get caught holding these shares when the market turns lower again.
Now, that doesn't mean you can't make money in the market right now. There are plenty of great stocks that can help you grow and protect your wealth.
The key is still to invest in companies that generate profits and make sure you don't pay too much for those quality stocks.
(Bonus points if you pick out stocks that also pay investors dividends. These companies may also use some of their cash to buy back shares.)
In today's market, it pays to be extremely selective about which stocks you'll invest in.
Please don't make the mistake of returning to the same stocks that lost you money over the last year.
Instead, use any rebound to sell out of speculative stocks that have been under pressure.
Then use the cash you receive to buy quality plays that will grow your wealth over time.
Here's to living a Rich Retirement,
Editor, Rich Retirement Letter