A phenomenon in financial markets where a sharp rise in the price of an asset forces traders who previously sold short to close out their positions
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What is a Short Squeeze?
Short squeeze is a term used to describe a phenomenon in financial markets where a sharp rise in the price of an asset forces traders who previously sold short to close out their positions. The strong buying pressure “squeezes” the short sellers out of the market.
A short squeeze often feeds on itself, sending the asset’s trading price even higher and forcing more short sellers to cover their positions.
As traders who previously sold short the asset must buy to cover their positions, the closing out of their short trades simply adds more buying pressure to the market, thus further fueling a rise in the asset’s price.
Summary
- A short squeeze is a phenomenon that occurs in financial markets when short sellers of a security are forced out of their positions by a sharp increase in the security’s price.
- Short squeezes are typically triggered either by unexpected good news that drives a security’s price sharply higher or simply by a gradual build-up of buying pressure that begins to outweigh the selling pressure in the market.
- As short sellers begin to exit their positions, it adds more buying pressure in the market, which can cause the price to rise even higher, forcing more short sellers to cover their positions.
How a Short Squeeze Unfolds
A short squeeze typically unfolds after a stock’s been declining in price for some time. The decline in price attracts more and more short sellers looking to profit from the fall in price.At some point, considerable buying pressure begins to enter the market. It is usually the result of one of two things.
It can be an instance of unexpected good news regarding the stock, such as a very favorable earnings report that far exceeds the expectations of market analysts. It can also be that technical traders begin buying the security as they see indications that it is oversold and, therefore, possibly ripe for a reversal to the upside.
When the new buying pressure that’s entered the market builds to the point where it begins to drive the stock’s price sharply higher, short sellers begin to see their profits erode – or even worse, their profitable positions begin turning into losing positions.
Fearing that the stock will continue its upward move, they move to exit their short positions with the necessary buy order. As previous short sellers enter buy orders to close out their positions, it adds fuel to the buying fire, attracting more buyers and pushing the stock’s price even higher.
As the stock’s price continues to rise, more short sellers are gradually squeezed out of their market positions.
How to Spot an Impending Squeeze
Technical traders monitor certain indicators that may reveal that a stock is ripe for a short squeeze to occur if substantial buying pressure begins to enter the market.
One is the short interest – the percentage of a stock’s total number of shares that are currently held by short sellers. When the percentage of the stock’s total shares that are currently sold short is significantly higher than the normal level, the likelihood of short squeeze is considered to be increased.
Another technical indicator that traders monitor is what is known as “days to cover.” It is a metric derived from comparing the total short-selling interest in a stock to its average daily trading volume.
The computation indicates the theoretical number of days, assuming average trading volume, that it will take for those who sold short to cover – exit – all of their positions. The higher the days to cover number is, the more prone the stock will be to a short squeeze.
Technical traders also look at indicators such as the Relative Strength Index (RSI), which are intended to indicate overbought or oversold conditions in a market. A market is considered to be oversold when the RSI reading is below 20.
Technical traders view the situation as indicating that the market may be due for an upside reversal in price movement. If the security’s price begins to rise, they will start buying it. If there is enough buying interest, short sellers may begin to get squeezed out of their positions.
More Resources
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FAQs
A short squeeze occurs when a stock moves higher and short sellers decide to cover their short positions or are forced to do so via margin calls. As these short sellers buy the stock, the price rises, potentially creating a situation in which more shorts have to cover.
Is a short squeeze illegal? ›
Although short squeezes may occur naturally in the stock market the U.S. Securities and Exchange Commission (SEC) states that abusing short sale practices is illegal. In addition, short sales used to manipulate the price of a stock are prohibited.
What is the biggest short squeeze in history? ›
What Was the Bigggest Short Squeeze in History? The biggest short squeeze in history happened to Volkswagen stock in 2008. Although the auto maker's prospects seemed dismal, the company's outlook suddenly reversed when Porsche revealed a controlling stake.
How do you identify a short squeeze? ›
How to identify a short squeeze. A key to identifying if a stock is ripe for a potential short squeeze is if a sizable number of investors are shorting the stock. Unlike buy-and-hold investors, short sellers have to buy back the shares they sold, as they are obligated to return the shares to the lender.
Who loses money in a short squeeze? ›
The combination of new buyers and panicked short sellers creates a rapid rise in price that can be stunning and unprecedented. A short squeeze gets its name because short sellers are being squeezed out of their positions, usually at a loss.
How high can a stock go during a short squeeze? ›
In such a case, they have to compete with each other in a sense, because others are also clamoring to get rid of their stock—and there's no fundamental limit to how high the stock could climb as brokers initiate margin calls forcing shorts to buy to cover.
How long does a short squeeze usually last? ›
In general, short squeezes tend to last somewhere between several days and several months. There is no real “typical” length for a short squeeze, as each one is unique.
Why are short squeezes bad? ›
Because short sellers exit their positions with buy orders, their exit can push prices higher, which leads to more covering of short positions, creating a vicious circle. The rapid rise in price can attract buyers looking to “jump on the bandwagon” to exploit the short squeeze.
What stops a short squeeze? ›
The only way to stop the hemorrhaging is to close out the short position by buying the stock and settling your debt. This dynamic reflects a technical imbalance between the demand for the shorted stock and its supply. Until an equilibrium point is reached, the stock price will continue to increase.
How high did GameStop go during the short squeeze? ›
As of January 28, 2021, the all-time highest intraday stock price for GameStop was $483.00 (nearly 190 times the low of $2.57 reached 9 months earlier in April 2020).
The short squeeze in Tesla Inc. shares was one of the most unexpected and profitable in the history of trading in decades.
What stock went up 1000 percent in a day? ›
Even so, the gains posted by Ambrx Biopharma (AMAM) in Friday's session are unusual and particularly eye-catching. The stock soared to the tune of a hardly believable 1007% after the company announced pleasing results from the mid-stage testing of its breast cancer drug ARX788.
How to trigger a short squeeze? ›
Short squeezes are typically triggered either by unexpected good news that drives a security's price sharply higher or simply by a gradual build-up of buying pressure that begins to outweigh the selling pressure in the market.
What is a good short squeeze score? ›
Most stocks have a small amount of short interest, usually in the single digits. The higher that percentage, the greater the bearish sentiment may be around that stock. If the short % of the float reaches 10% or higher, that could be a warning sign.
What is the best indicator for a short squeeze? ›
Two popular indicators used to identify a short squeeze are the relative strength index (RSI) and stochastic oscillator, both of which are available on our online trading platform, Next Generation.
What happens when a short squeeze fails? ›
If that happens, the short seller will be forced to buy back the stock in order to return the shares borrowed. Because short sellers exit their positions with buy orders, their exit can push prices higher, which leads to more covering of short positions, creating a vicious circle.
Who wins in a short squeeze? ›
A short squeeze occurs when a stock that is heavily shorted experiences a rapid increase in price that forces short sellers to cover their positions by executing buy orders at market price. This generates a massive imbalance between supply and demand where short sellers lose, and the bulls of Wall Street win.
Is short squeeze bullish or bearish? ›
Most stocks have a small amount of short interest, usually in the single digits. The higher that percentage, the greater the bearish sentiment may be around that stock.
