Stock Quotes in this Article: CMG, NILE, RAX

WINDERMERE, Fla. (Stockpickr) -- When a company reports solid earnings and favorable guidance, and when it’s heavily shorted going into that report, the stock can produce monster gains that you just don’t see every day in the markets.

That’s why during earnings season, I scan the market for stocks that I think have a strong probability of producing strong results that will please the bulls on Wall Street, giving the stocks a good chance of being caught in a short squeeze. Nothing will hurt short-sellers more than having a bet against a company that reports bullish results, which often forces them into covering their positions if the stock acts positively and starts to skyrocket.

What I really like to search for are heavily shorted stocks that are already in solid uptrends. These are the type of stocks that I want on my radar prior to their earnings report. For whatever reason, bears love to bet against stocks that are in solid uptrends. They often believe that these stock are overvalued or due for a fall, even though the technical picture is extremely bullish. People like to fight trends, and I think one of the main reasons that we see investors do this is because they trade their opinion rather than follow price action.

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    It's a recipe for losing money. Just think about all of the bears who’ve been fighting the trend and shorting this market since last August. Many of those bears have made great fundamental cases for why the market shouldn’t be going higher, but that sure hasn’t stopped stocks from levitating to the upside.

    So when I look at companies that are due to report earnings soon, I'm searching for stocks that have the trend-fighting bears' attention and could make for fantastic short squeeze candidates.

    Here's a look at a some stocks that could experience a big short squeeze when they report earnings.

    Chipotle

    One stock that has the potential for an earnings short squeeze is Chipotle Mexican Grill (CMG), which engages in the development and operation of fast-casual, fresh Mexican food restaurants in the U.S. and Canada. Chipotle is scheduled to report its results on Thursday after the market close.

    Chipotle was a market leader last year , and it’s off to a hot start in 2011, with shares up around 16%. Wall Street analysts are looking for the company to report revenue in a range of $451.6 million to $478.4 million. Chipotle is expected to beat the Street consensus, and analysts will be looking to hear how the company’s new Asian restaurant concept is going.

    Concerns for the current quarter at Chipotle include the bad weather that has been sweeping across the U.S., which might have put a damper on sales, and rising commodity cost, which some investors fear might hurt Chipotle's bottom line. I think the bad weather talk is a bit overblown, and the company has a low-priced menu, making it easy to pass along rising food costs.

    Keep in mind that food and beverage costs only eat up around a third of Chipotle’s revenue. I just don’t see a modest rise in menu prices hurting the company's bottom line enough to keep it from reporting a strong quarter. Of course, that’s if business at Chipotle is still on fire, which I think it is, judging by the long lines that I see whenever I go there to eat.

    As of Jan. 14, the current short interest as a percentage of the float for CMG sits at around 9.1%. That’s a significant short interest when you consider that the tradable float for CMG is only 30.25 million shares. Those same shorts have also been increasing their bets from the last reporting period by around 9.9% to a total number of shares shorted at 2.76 million.

    From a technical standpoint, the stock has a ton of support at around $212 a share and its currently trading above both the 50-day and 200-day moving averages. The stock recently broke out above some past overhead resistance at around $240 a share and it now looks poised to challenge its next breakout level at $263 a share.

    If you want to play this stock for a earnings short squeeze, you could buy it now at around $248, or buy it once it breaks out above $263 with a stop set below the prior breakout point at $240. You could also place a stop close to the 50-day moving average of $230.78.

    If this stock does trade above $263 a share on strong volume that clocks in much higher than the three-month average activity of 963,000 shares, then I think it will be well on its way towards $300 a share or much higher.

    As of the most recent reporting period, Chipotle shows up in the portfolios of Navellier & Associates and Renaissance Technologies. Jim Cramer recently included the stock as one of the reasons he's still bullish, and with a B+ buy rating, it's one of TheStreet Ratings' top-rated restaurant and hotel stocks.

    Rackspace

    Another potential earnings short squeeze trade is market leader Rackspace (RAX), which operates in the hosting and cloud computing industry. It is due to report its results on Thursday after the market close.

    This stock is another hot name off to a blazing start this year, with shares up around 17%. Wall Street analysts are looking for revenue to come in in a range of $206 million and $213.1 million.

    Rackspace is one of the top-performing cloud computing stocks on Wall Street, but it often gets a bad rap because it’s not in the league of a best-of-breed cloud names such as Salesforece.com (CRM) or Akamai Technologies (AKAM). The stock is currently trading at a very rich valuation of around 68 times forward earnings. Rackspace is considered a high-value acquisition target, and its market cap is only $4.6 billion, so it would be very easy for a big player who wants in on the cloud trend to come in and snap up the company.

    One of Rackspace’s main competitors, Savvis (SVVS), just reported a decent quarter on Tuesday that showed a narrower-than-expected fourth-quarter loss. Despite the loss, the company said 2010 revenue growth was 15% and revenue growth for the fourth quarter was up 17%. Savvis is up a whopping 33% so far in 2011, and the stock has rarely been weak, even on earnings day. I think this bodes well for Rackspace since Savvis’ results show that end-demand for the entire sector could indeed be stronger than many think.

    Keep in mind that cloud company Acme Packet (APKT) recently reported a very strong earnings report and raised its 2011 outlook. Shares of Acme Packet soared following that report, from around $56 a share to its current price of close to $71. I think this shows that the shorts are pressing their bets on the cloud names since they had some modest success in knocking down F5 Networks (FFIV) following their earnings report a few weeks ago.

    As of Jan. 14, the current short interest as a percentage of the float for Rackspace is a rather large 19.1%. That means that out of the 97.87 million shares in the tradable float around 19.09 million are currently sold short by the bears. This is a very large short position for a stock with a reasonably small float. A massive short squeeze could easily kick off here for Rackspace if the company can deliver on earnings day.

    From a technical standpoint, Rackspace is in a clear uptrend with the stock making higher highs and higher lows for months now. The stock recently broke out above some past overhead resistance at around $35 a share. If the bears do hit this stock following its earnings report, then it might be a good idea to look to buy shares on any pullback toward the 50-day moving average of $32 a share. That’s an area that the stock has only traded below for about two days in the last six months. However, I think there’s a good chance this stock short squeezes when it reports, so keep this name on your radar.

    Blue Nile

    One final stock that could be setting up for a big earnings short squeeze is leading online retailer of diamonds and fine jewelry Blue Nile (NILE), which provides its customers with a superior way to buy engagement rings, wedding rings and fine jewelry. It is set to report its results on Thursday after the market close.

    Blue Nile is off to a modest start in 2011 with shares up around 5.8%. Wall Street analysts are looking for revenue to come in between a range of $107.52 million to $114.3 million. For the full year, analysts are looking for Blue Nile to post earnings per share of $1.13. During the same period last year, the company reported EPS of 35 cents a share on sales of $103 million.

    What I love about this stock going into its earnings report is that shares of Blue Nile are trading very close to its 52-week high of $63.72. Even more important, Blue Nile just hit that 52-week high on Monday, which clearly shows that traders are willing to pay up for shares heading into their earnings report. This is exactly how I want to see a stock trending right before its time to report earnings because it increases the probability that the stock is setting up to move much higher.

    As of Jan. 14, the current short interest as a percentage of the float for NILE is a whopping 35.9%. That means that out of the 12.2 million share float, around 5.1 million shares are currently sold short by the bears. This is an extremely small float combined with a very big short interest. If this company reports what the bulls are looking for, you’re going to see a healthy short squeeze develop for Blue Nile.

    From a technical standpoint, shares of Blue Nile have run into some past overhead resistance at around $63 to $64 a share. Three times in the last two months the stock has traded up towards those levels and then sold off. Basically, this stock has been trading in a range from $54 to $63 a share for the past few months. Market players might want to buy this stock on any weakness heading into their earnings report down to the 50-day moving average of $57.50. The conformation of a massive short squeeze will be confirmed if the stock breaks out above the $63 to $64 a share. If you see the stock break out prior to or after earnings, then I would get ready to enjoy the squeeze higher.

    With a C+ hold rating from TheStreet Ratings, Blue Nile is one of the top-rated Internet catalog and retail stocks.

    To see more potential earnings short squeeze candidates, including CBOE Holdings (CBOE), Wynn Resorts (WYNN) and Whole Foods Market (WFMI), check out the Earnings Short Squeeze Plays portfolio on Stockpickr.

    -- Written by Roberto Pedone in Winderemere, Fla.

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    At the time of publication, author had no positions in stocks mentioned.

    Roberto Pedone, based out of Windermere, Fla., is an independent trader who focuses on stocks, options, futures, commodities and currencies. He is also an outside contributor to Beconequity.com and maintains the website Maddmoney.net, which he sold to Blue Wave Advisors in 2008. Roberto studied International Business at The Milwaukee School of Engineering, and he spent a year overseas studying business in Lubeck, Germany.