What Is A Short Squeeze?

A short squeeze is a situation where too many traders have shorted a stock, and it unexpectedly jumps in value, forcing them to buy the stock to cover their losses. The result is an influx of buying pressure, which in turn makes the price jump even higher.

A short squeeze is reinforced by the risk of unlimited loss potential and by the broker’s margin calls forcing short sellers to buy their shorts.

Even the most experienced short sellers can be left surprised by these abrupt price rises. A short squeeze is almost always escalated by market psychology. Herd behavior plays a vital role in exacerbating prices, meaning that once a trader notices other short sellers covering their stocks, due to fear of losing their profits, they will show the same behavior they’ve observed.

This sudden and unexpected movement can be credited to technical innovation, sudden buying pressure, positive news, or any positive development surrounding a company’s fundamentals. Once a short squeeze event has begun, it’s very difficult to stop.

By analyzing the short interest ratio and short interest, a trader can easily determine if the stock is heavily shorted and estimate how many days it would take for short sellers to cover their positions. However, these methods alone are insufficient, as the events that trigger a short squeeze are often unexpected.

A short squeeze can happen due to a positive earnings report or a stock breakout above key resistance levels, both indicating a clear rise in value—and a subsequent increase in traders coming to buy more shares.

News of regulatory approvals, new partnerships, or technical breakthroughs can act as triggers for a short squeeze. Even if they are later proved as misinformation or a bad assessment, the value of the shorted stock had already been increased and would have forced short sellers to back out of their shorted positions.

Other causes may involve numerous retail investors coordinating online to cover a short position, similar to the GameStop short squeeze in 2021. The same can be observed in low float stocks with high short interest, where there are a lot of short sellers and not enough shares to cover, leaving the existing short sellers in an undesirable position.

The underlying trigger for a short squeeze lies in the optimism that the stock will become valuable. Traders who are not short-selling are keen on buying stocks that are likely to become more valuable, making the price rise even more. The optimism can be triggered by any of the aforementioned instances that result in a short squeeze.

A short squeeze can be devastating. If a trader doesn’t acknowledge that a short squeeze is ongoing, the longer the trader is indecisive, the higher the costs will rise. Initial rapid price spikes will make traders behave chaotically and can force them to make emotional decisions in a panicked state.

The main goal for short sellers during a short squeeze is to prevent the escalating losses that are induced not only by the panicked state of the market and mass cover deals but also by the brokers enforcing margin calls. A trader must be informed and alert, especially in volatile or speculative environments like the one created by a short squeeze.

1. Low float stock with high volume which indicates that movement can be very volatile, signifying a short squeeze.
2. Recent bullish news can push stocks to rise in value, negatively impacting short sellers.
3. Checking for high short interest percentage can save the trader from shorting volatile stocks.
4. A technical stock breakout above resistance is a long position, meaning the stock will rise in value, inducing a short squeeze.
5. By using brokerage platforms like TradeZero, a trader can monitor short interest, short interest ratio, and stock movement using real-time tools to determine the heaviness of the short and the potential of a short squeeze.
6. High fees on short borrow stocks indicate an unusual amount of demand, which can lead to a potential short squeeze setup.

Non-influential negative news makes the trader speculate that shorting can make profits, however, the company can remain unaffected, which can lead to a short squeeze.

A trader can remain protected by staying informed of the latest news, monitoring the stock with brokerage platform tools, and shorting conservatively with careful attention to risk management:

1. By using stop-loss orders on shorted stocks, a trader is able to limit the risk associated with a loss.
2. Low-float stocks and parabolic movers are highly risky stocks that should be avoided, as only a low percent of traders will be able to earn a profit from them.
3. Traders must approach position sizing conservatively, as a general risk management measure.
4. A trader has to monitor short interest data using a broker's platform to analyze how many company shares are sold short and not yet covered to prevent holding positions with high short interest ratio.
5. Traders should stay away from stocks with a high volume of shorts to minimize risks.
6. Staying updated on news regarding the shorted stock, as well as market trends and the sentiment of fellow traders, can help to protect the trader from sudden market updates.
7. Traders can protect themselves by monitoring for volatility in shorted stock, which can be an early indicator of a short squeeze.
8. Traders should be cautious of overstaying in a short position due to the sudden nature of a short squeeze.

Traders can decrease the position sizing of their shorts when expecting quarter reports, regulatory approvals, or other major catalysts that can lead to volatility.

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