Tesla Shorts Keep Getting Squeezed

Tesla Inc TSLA shares rallied more than 19% Monday, setting a new all-time closing high of $780.

Tesla's stock traded higher by another 7.3% to $837 Tuesday morning. It was trading under $300 just six months ago.

While the massive move in Tesla's stock has left many investors desperately searching for fundamental news from the company, another factor may have impacted the stock this week: a high level of short interest.

How Shorts Influence A Stock

Short interest becomes more meaningful for investors when short sellers want to exit their short positions, something which requires the short seller to buy the stock in order to return the shares they originally borrowed from their broker.

This is where the infamous "short squeeze" comes into play. Short squeeze is the phrase used to describe an elevated level of buying interest following periods of extreme bearishness when many market participants may be calling for downside in the stock.

Related: Here's How Tesla Shares Will Hit $7,000 By 2024

Short Squeeze: What To Watch For

Investors may want to consider a few factors when looking for possible short squeeze plays:

• Short interest in a stock
• Recent downside pressure
• Bearish sentiment while stock trading at or near 52-week/all-time highs
• An upcoming or just-recently passed catalyst

Tesla's Short Squeeze Potential

Tesla arguably had three of those factors in play Monday:

• Short interest about 19%. Market participants may consider short interest over 10% as a relatively high level of short exposure. Short interest getting closer to the 20% of a company's float is would be considered high by most investors. The highest short interest companies currently traded in the U.S. have short interest nearing 40-50%.
• Shares up 24% over just the last five days of trading and up 40% over the last month. This upside put shares at new all-time highs. Amid this price action, pundits and analysts called for downside in the stock.
• The company reported better-than-expected earnings results after the market close on Jan. 29.

What Should Investors Do…

...in the face of potentially a large-scale short squeeze impacting a stock?

• Don't forget your fundamental thesis: While momentum and technical pressures often move a stock intraday, a company's operations and business practices will ultimately be the factor deciding on long-term direction of the stock. Warren Buffett is famously quoted as ignoring short-term market volatility and focusing only on long-term returns
• Understand tape readers are dominating the trade: These traders can appropriately react to less-certain fundamental information, technical information and often times make many more trades than an investor. For one who doesn't sound like they should be competing against that kind of source… don't! It's likely nothing is forcing a long-term investor to, for example, trade near term given recent price volatility.
• Identify notable near-term areas of support and resistance: If it's assumed technical and momentum traders are dominating the trade, use some of the tools of those kinds of traders. Basic support and resistance levels can give traders and investors alike near-term targets to focus on -- if only to watch how a stock reacts around that price level more so than to take action.