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4 Beaten-Down Stocks with Short Squeeze Potential

Is the stock market on the cusp of another major breakout? It looks like that could be the case as the market takes aim at another key S&P 500 resistance level at 1,150.

Despite all the talk of the current September run coming on very low volume, the market has continued to defy the odds and move higher, trading up in the face of a bearish news environment. A clear example of this is last Tuesday’s rally, which occurred despite the drop in the consumer confidence reading, now at seven-month lows.

While the current market behavior might seem counterintuitive, it's really not all that surprising. Markets tend to trade on future prospects, not on current data. So the market could be saying that 12 months out, the economic recovery will be in full swing. However, it's also possible that much of September's run was nothing but short-covering and possibly a sucker's rally.

Either way, we're going to find out very soon what this market is made of. And if the S&P 500 can manage to take out 1,150, then, plain and simple, we're going to trade much higher, at least in the near term. From a technical perspective, a move above 1,150 should set up a test of the next area of significant resistance at 1,173. A move above 1,173 will almost certainly mean we test the yearly highs on the S&P at around 1,220.

If the market is setting up to break out again, it's time to look for some stocks that have been beaten down and are heavily shorted and could be in store for a short squeeze. Since so many leaders, including Baidu.com and Apple , have already make big moves, the market could start to rotate into the beaten-down names that haven't participated as much in the September rally.

A short squeeze results when the price of a stock rises and investors who short-sold the stock rush to buy it to cover their short position. As the price of the stock increases, more short-sellers feel driven to cover their positions. As these short-sellers cover their positions the price of the stock skyrockets.

With this in mind, let's take a look at a number of beaten down stocks that could be setting up to experience some big short squeezes.

1. One stock that is under heavy pressure from the short-sellers is Research In Motion. This company designs, manufactures and markets wireless solutions for the worldwide mobile communications market, including the BlackBerry smartphone.

Currently, RIM's short interest stands at 5.7% of the tradable float of 463 million shares. What's interesting here is that the total number of shares held short by the bears actually declined from the Aug. 31 to Sept. 15 reporting periods by 11.5%, from 31 million shares to 27 million shares. This decline in short interest could have been in anticipation of the company's launch of its new tablet device, dubbed the PlayBook.

The new PlayBook is going to compete directly with Apple's popular iPad tablet device. This will not be an easy task for RIM, but if the company can generate excitement for the new product, it could sell deep into its already large corporate installed base. Some of the early reviews show the PlayBook beating the iPad out in size and portability, as well as with its high-quality cameras and a much smarter dual-core processor setup.

From a technical perspective, shares of RIM have been beaten down tremendously this year, with the stock down more than 28%. The bears have been winning this battle, but that might be about to change rapidly. Recently, RIM reported a robust second-quarter earnings report, but even more significant was the massive volume of 57 million shares that traded the day following the report.

The next two trading sessions, which were also up days, saw huge volume of over 30 million shares, compared with the three-month average trading volume of 17 million shares. This action is telling me that it's possible that RIM is forming a bottom. As long as the stock doesn't take out its September lows of $42.53 a share, I think RIM will continue to rise and eventually move back toward the 200-day moving average of $61.59.

2. Another beaten-down stock with a high short interest is Cree, which develops and manufactures light-emitting diode, or LED, products, silicon carbide and gallium nitride material products and power and radio frequency products.

The bears are leaning all over this stock, with more than 20.08% of the tradable float of 103 million shares currently sold short. The short interest for Cree actually went up from the Aug. 31 to Sept. 15 reporting periods, from 15 million shares to 18.9 million shares sold short. That marks a 23% increase in the total short interest. The number of days of average share volume it would require to buy all of the shares that were sold short during the most recent reporting period is 2.3 for Cree.

The bears have been dominating the Cree trade and they've successfully knocked the stock down from its April highs of around $80 to its current price level near $55 a share. Most of Cree's revenue comes from the growing LED business, which is primarily geared towards selling energy-efficient lighting to businesses around the globe. As long as that market continues to grow, Cree's stock should rebound from its current depressed levels.

From a technical perspective, market players should make note of the huge volume selling that was followed by big volume buying from Sept. 8 to Sept. 10, which has for the time being marked a bottom in the stock. It looks like everyone who wanted to get out of the stock sold into the Sept. 8 decline, which saw volume come in at 17 million shares vs. the three-month average daily volume of 4.3 million. Watch for this stock to break above $57 and $61 a share as an indicator that it is ready to test the gap down in price from over $70 that occurred back in mid-August.

3. The bears seem to love betting against Vulcan Materials, which engages in the production and sale of construction aggregates for the infrastructure industry, primarily in the U.S. Currently, the short interest sits at around 10% of the tradable float of 127 million shares. It would take 8.8 days of average share volume to buy all of the shares of Vulcan that were sold short during the most recent reporting period.

The bears have taken this stock apart, dropping it more than 30% so far in 2010, from close to $59 a share to its current price of around $37. It's understandable that the bears are leaning on Vulcan as an easy way to short the struggling housing and construction markets, but if housing picks up in anyway, or if the Federal government's infrastructure projects start ramping up, then Vulcan could see a significant short squeeze.

From a technical perspective, some decent buying volume, above the 3-month average daily volume of 1.5 million shares, has started to come into the stock recently. This bullish volume activity should set up Vulcan for a run toward the 50-day moving average of $39.50. If this stock can get above the 50-day, then it should easily trade into the mid-$40s in short order.

4. One final stock to consider for a big short squeeze candidate is Tesla Motors , which engages in the design, manufacture and sale of electric vehicles and advanced electric vehicle power train components. The current short interest for Tesla sits at around 12.5% of the tradable float of 47 million shares. It would take 10.4 days of average share to buy all of the shares of Tesla that were sold short during the most recent reporting period.

This stock has been beaten down badly by the bears since its IPO earlier this year, which saw shares reach as high as $30.50 a share. Currently, the stock is trading at around $22 a share.

This stock is very speculative, but it's an innovative company that could have a very bright future. That bright future is being built around the company's key product, the Roadster, an electric sports car that consumes no gas and produces no exhaust.

The Roadster is powered by an advanced lithium-ion battery pack, which helps to lower the total cost of owning a car. Think no gas bills, fewer repairs and less of the routine maintenance that you see with gas-powered cars.

From a technical perspective, if this stock can manage to break above some heavy resistance at around $22.25 to $23.16 a share, then I think it's going to make a huge move to the upside. Clearing those price levels would put the stock back in play for a run toward the former highs at $30.50.

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Disclosures:

TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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