A short squeeze is a situation in which short sellers are forced to close their positions at a loss, which leads to a sharp rise in the price of an asset. Short squeezes can be caused by a variety of factors, including increased demand for the asset, release of new positive news about the asset, or closing of short positions by other market participants.
In most situations, the stock market has several states: sideways movement or flat, growing or falling trend, temporary correction. All conditions have a fundamental explanation. But sometimes there are sharp abnormal upward movements in the market. The price, with its unusual speed and volatility, can soar tenfold in a few days and fall just as quickly. One of the reasons for such a sharp surge is short squeeze.
Start trading stocks with DegiroA short squeeze is a situation in which short sellers are forced to close their positions at a loss, which leads to a sharp rise in the price of an asset.
A short squeeze can be caused by a variety of factors, including:
Increased demand for the asset. If demand for an asset increases while supply remains the same or decreases, this can lead to an increase in the price of the asset. When short sellers see that the price of the asset is rising, they are forced to close their positions to avoid even greater losses
Release of new positive news about the asset. If new positive news is released about an asset, this can increase demand for it and lead to an increase in price. When short sellers see that the price of the asset is rising, they are forced to close their positions to avoid even greater losses
Closing of short positions by other market participants. If other market participants begin closing their short positions, this can lead to increased demand for the asset and an increase in price. When short sellers see that the price of the asset is rising, they are forced to close their positions to avoid even greater losses
To understand how a short squeeze works, it is important to understand how short selling works. Short selling is when investors sell an asset that they do not own. They do this by borrowing the asset from a broker and promising to return it in the future.
When an investor opens a short position, they commit to selling the asset at a certain price. If the price of the asset falls, the investor can buy the asset at a lower price and return it to the broker at a profit. However, if the price of the asset rises, the investor must buy the asset at a higher price than they sold it for and return it to the broker at a loss.
In the case of a short squeeze, when the price of the asset suddenly rises, short sellers are forced to close their positions at a loss. They do this by buying the asset at a higher price than they sold it for. This leads to even more of an increase in the price of the asset, which can further exacerbate the short squeeze.
There are several signs that can indicate the possibility of a short squeeze. These include:
High level of short positions. If a large number of short positions are open in the market, it means that there is a significant risk for short sellers. If the price of the asset starts to rise, these sellers will be forced to close their positions at a loss, which could lead to a short squeeze
Sharp rise in the price of the asset. If the price of an asset suddenly rises, it could be a sign that short sellers are starting to close their positions. This could lead to even more of an increase in the price of the asset, as short sellers are forced to buy the asset at a higher price than they sold it for
Large volume of trading. If the volume of trading in an asset suddenly increases, it could be a sign of a short squeeze. This is because short sellers and other market participants are eager to buy the asset to close short positions or take advantage of the rising price
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It is important to note that the presence of one or more of these signs does not necessarily mean that a short squeeze will occur. However, if you see these signs, it is worth closely watching the market to determine if there is a risk of a short squeeze.
Here are some additional signs that could indicate a short squeeze:
Negative news about the asset. If negative news is released about an asset that is heavily shorted, it could trigger a short squeeze as investors rush to buy the asset before the price falls further
Social media chatter. If there is a lot of chatter on social media about an asset that is heavily shorted, it could be a sign that investors are planning to buy the asset in an attempt to trigger a short squeeze
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It is important to note that short squeezes can be very risky for short sellers. If the price of an asset suddenly rises, short sellers can suffer massive losses. In some cases, short squeezes can even lead to the bankruptcy of hedge funds.
There have been several famous short squeezes in history. One of the most famous examples was the GameStop short squeeze in 2021. In this case, retail investors, banding together on the Reddit platform, began buying GameStop shares, which led to a sharp rise in price. This led to many hedge funds that had short positions on GameStop being forced to close their positions at a loss.
Image: GameStop short squeeze
Another famous example of a short squeeze was the Volkswagen short squeeze in 2008. In this case, investors who believed that Volkswagen would be acquired by Porsche began buying Volkswagen shares, which led to a sharp rise in price. This led to many hedge funds that had short positions on Volkswagen being forced to close their positions at a loss.
Image: Volkswagen short squeeze
To profit from a short squeeze, you need to buy an asset that is in a short squeeze zone. This means that there are a large number of short positions open in the market, which creates risk for short sellers. If the price of the asset starts to rise, these sellers will be forced to close their positions at a loss, which could lead to an even greater rise in the price of the asset. Find out what short selling is and how it makes (and loses) money in the TU article.
Here are some ways to profit from a short squeeze:
Buy shares. If you believe that the price of the asset could rise, you can buy it directly. If the price of the asset does rise, you can sell it for a profit
Buy call options. Call options give you the right to buy an asset at a certain price in the future. If the price of the asset rises, you can use your call option to buy the asset at a lower price than the current price, and then sell it for a profit
Buy futures. Futures are contracts that obligate you to buy or sell an asset in the future at a certain price. If the price of the asset rises, you can sell your futures for a profit
Note:
It is important to note that short squeezes can be very risky. If the price of the asset does not rise, you could lose money.
Trading a short squeeze can be very risky. Here are some of the risks to consider:
Unpredictability. Short squeezes can be very unpredictable. Even if you think the price of an asset will rise, it may not
Large losses. If the price of the asset does not rise, you could suffer large losses
Liquidity. Short squeezes can lead to decreased liquidity in the market. This can make it difficult for you to buy or sell an asset at your desired price
Regulation. Regulatory bodies may take action to regulate short squeezes. This could limit your ability to trade a short squeeze or make it more expensive
Here are some tips that can help you reduce the risks of trading a short squeeze:
Do your research. Before you trade a short squeeze, make sure you understand the fundamentals of the asset and the factors that could affect its price
Don't invest more than you can afford to lose. Short squeezes can be very unpredictable, so it is important to be prepared for losses
Be patient. Short squeezes can take some time to unfold. Don't try to force things
Note:
Short squeezes can be very risky for short sellers. If the price of an asset suddenly rises, short sellers can suffer massive losses. In some cases, short squeezes can even lead to the bankruptcy of hedge funds.
A short squeeze is a situation in which short sellers are forced to close their positions at a loss, which leads to a sharp rise in the price of an asset. Short squeezes can be caused by a variety of factors, including increased demand for the asset, release of new positive news about the asset, or closing of short positions by other market participants. Short squeezes can be very risky for short sellers and can even lead to bankruptcy.
To make money on a short squeeze, you need to buy an asset that is in a short squeeze zone. This means that there is a large number of short positions open in the market, which creates risk for short sellers. If the price of the asset starts to rise, these sellers will be forced to close their positions at a loss, which could lead to an even greater rise in the price of the asset.
No, creating a short squeeze is not illegal. However, there are rules in place to prevent market manipulation, which could lead to a short squeeze. For example, exchanges may require investors who take short positions to provide collateral to ensure that they can close their positions if the price of the asset rises.
A short squeeze benefits those who are holding long positions, meaning they've bought assets with the expectation that their prices will rise. When a short squeeze occurs, it forces those who had shorted the assets (betting on their prices falling) to buy them back to cover their positions. This increased buying activity drives the prices even higher, creating gains for the long holders. Traders who correctly anticipate and participate in a short squeeze can profit from the rapid price increase. However, it can lead to significant losses for those who were shorting the assets.
Waiting out a short squeeze can be challenging, as it involves enduring potential losses until the squeeze subsides. Traders who are short may face margin calls and forced liquidation if the squeeze intensifies. The duration of a short squeeze is unpredictable, making it difficult to adopt a passive strategy. In some cases, waiting out a short squeeze may result in substantial losses, emphasizing the importance of risk management and timely decision-making.
A broker is a legal entity or individual that performs as an intermediary when making trades in the financial markets. Private investors cannot trade without a broker, since only brokers can execute trades on the exchanges.
A short squeeze is a situation in which short sellers are forced to close their positions at a loss, which leads to a sharp rise in the price of an asset.
Trading involves the act of buying and selling financial assets like stocks, currencies, or commodities with the intention of profiting from market price fluctuations. Traders employ various strategies, analysis techniques, and risk management practices to make informed decisions and optimize their chances of success in the financial markets.
An investor is an individual, who invests money in an asset with the expectation that its value would appreciate in the future. The asset can be anything, including a bond, debenture, mutual fund, equity, gold, silver, exchange-traded funds (ETFs), and real-estate property.
Short selling in trading involves selling an asset the trader doesn't own, anticipating its price will decrease, allowing them to repurchase it at a lower price to profit from the difference.
Alex Smith is a professional day trader for a proprietary trading firm within the foreign exchange (forex) and crypto markets. His area of expertise is day trading and swing trading within the 15min-4hr time frames for both the London and NY open.
Dr. BJ Johnson is a PhD in English Language and an editor with over 15 years of experience. He earned his degree in English Language in the U.S and the UK. In 2020, Dr. Johnson joined the Traders Union team. Since then, he has created over 100 exclusive articles and edited over 300 articles of other authors.
Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO).
