Short Squeeze: Definition, Causes, and Examples

If the stock price starts to rise instead of fall, short sellers face potential losses as they must eventually buy back the borrowed shares at a higher price. This buying may proceed automatically, for example if the short sellers had previously placed stop-loss orders with their brokers to prepare for this possibility. Alternatively, short sellers simply deciding to cut their losses and get out (rather than lacking collateral funds to meet their margin) can cause a squeeze. Short squeezes can also occur when the demand from short sellers outweighs the supply of shares to borrow, which results in the failure of borrow requests from prime brokers. This sometimes happens with companies that are on the verge of filing for bankruptcy. 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.

Betting on a Short Squeeze

When something happens which drives the price of the stock up, the short sellers rush for the exits all at once, attempting to buy to close their positions. This adds fuel to seeking short term opportunities with a swing trading the force propelling the stock price higher and irrationality sets in. What happened to Game Stop’s share price in 2021 is a good example of a short squeeze in action.

Naked shorting still occurs in the market, however, and it contributes to short squeezes by allowing additional shorting that may not actually exist. However, naked shorting in a short squeeze can also help balance the stock market when it forces a price drop. Short selling happens when many investors believe a stock is overvalued, and therefore will eventually decline in price. When they are correct, they can pocket the difference between the price Roberto rivero they originally borrowed the stock at and the resale price. 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.

Short Squeeze

1. Bond ratings, if provided, are third party opinions on the overall bond’s credit worthiness at the time the rating is assigned.
2. Even when a stock price unexpectedly skyrockets, what goes up must come back down eventually, and short squeezes are usually short-lived.
3. Squeezing the shorts can also be done with commodities that are traded through futures contracts.

U.S. residents who open a new IBKR Pro account will receive a 0.25% rate reduction on margin loans. Get stock recommendations, portfolio guidance, and more from The Motley Fool’s premium services. The cap rate is an important metric used in commercial real estate investing in comparing property values. Also, looking at the Volkswagen chart above, notice the price went down nearly as fast as it went up. By the end of 2008, the stock’s price was basically back to where it started before the squeeze. Gordon Scott has been an active investor and technical analyst or 20+ years.

Traders and investors should conduct thorough research, stay informed about market dynamics, and implement effective risk management strategies. By doing so, you can navigate the complexities of short squeezes with greater confidence and increase their chances of success. If, for example, NoGood Co. reported better-than-expected earnings and its stock price jumped to $120, then panicked short-sellers might rush to close out their positions before the share price kept climbing.

How to Avoid a Short Squeeze

There’s the “short percentage of the float” – that’s the percent of the shares available for trading that are currently being held short. At one point, more than 100% of GameStop’s float was sold short – an excessively high number meaning that every share available was borrowed at least once to be sold short, but some were borrowed multiple times. Panic-buying begets more panic-buying, egged on by speculators who know the situation the short sellers are in and actively try to put the screws to them. Squeezing the shorts can also be done with commodities that are traded through futures contracts. In this case, traders would take long positions in the futures contracts involving a certain commodity at a low price and then would try to purchase the entire supply of that same commodity. 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.

Thorough analysis and a holistic understanding of market dynamics are necessary to make informed investment hirose financial uk review decisions. Of course, you can’t simply sell what you don’t own with no consequences — at some point, those borrowed shares have to be returned. When that day comes, the investor needs to buy shares in the market to be able to return them to the lender.