The Short Squeeze Phenomenon Explained

Short trading is a very risky venture – probably one of the riskiest calls you could make while trading. Short trading basically means you bet on a stock that doesn’t even belong to you. You owe it to someone, and you want its price to fall so you could return it cheaper and pocket the difference as your profit.

What if the stock doesn’t fall in price? Even worse, what if it initially falls just like you predicted and then jumps up in a mad leap, increasing in value multiple times over? It can very well happen, for one reason or the other. The most common type of such market action is called Short Squeeze.

Short Squeeze

What is even short trading?

Short Squeeze, as evident from the name, has everything to do with short trading. But what is a Short Squeeze?

Short trading (aka shorting) is one of the main trading approaches, where you bank on the stock losing value rather than growing it. Usually, people buy the stock low and sell it high, which is called long trading. Buying high and selling low, by contrast, is known as short trading.

But why on Earth would you bet against your own stock? Well, the whole shtick is that it’s not even your stock. This is how it happens:

  1. A trader located a stock projected to fall in value.
  2. They borrow this stock and immediately resell it at the current market value.
  3. When the stock price falls low enough, the stock is bought back.
  4. This new cheap stock is returned to whoever it was borrowed from.

The difference between the money this asset was initially sold for and the final price you buy the stock for in order to return it is your profit. It’s complicated, but it sometimes does wonders – especially when it’s common knowledge that the stock is going to fail. Sometimes it doesn’t, however, even despite the common knowledge. 

What is a Short Squeeze?

Short Squeeze is a phenomenon in which the market price suddenly drives up despite being in a steadily bearish trend recently. Small price surges during such phases are nothing special, but the Squeeze is characterized by its size and gradually increasing intensity.

These are usually caused by some news or an unexpected market action that suddenly bolster the price. On its own, it could be hammered back down in no time, but Squeeze happens when a large portion of the currently traded stock is traded short. As a result, the participants will try to quit their positions as soon as possible when this sudden price surge happens.

‘Quitting’ in short trading implies buying the stock back in order to return it, while the price is still low. If there are many shorting participants, the majority will try to buy the stock back. This sudden rise in demand, in turn, drives the price even higher. In conjunction with the previous growth, it creates a frantic situation.

The ‘squeeze’ in the name reflects the way price jumps up from a largely stagnant market situation, as if someone squeezed it really hard.

How does it come to be?

So, how does a Short Squeeze work? The Squeeze events aren’t scarce, although they also aren’t homogenous. Many various reasons can kick-start it, but the most usual factors can amount to these two:

  1. A large portion of the overall stock volume on the market has to be in some stage of short trading.
  2. A powerful economic event (market action or news) must turn the trend upwards with enough momentum.

The portion of shorted stocks on the market is called a ‘short interest’. It’s a percentage of assets currently involved in short trading out of the whole volume on the market. For instance, 15% interest means 300,000 shares are now being shorted in the market of 2,000,000 shares.

The definition of what you can regard as ‘large interest’ varies from market to market, but even 15% is usually enough to kick-start a Squeeze (given, of course, that any particularly strong bullish pull happens prior to it).

As for the event, it can vary even more. Usually, the event must be powerful enough to both negate the previous bearish trend and introduce a new bullish one. The news may come that the issuer company has solved its financial difficulties and introduced a new, amazing product.

Alternatively, the market can simply be visited by a wave of new buyers – anything can happen. The important thing to keep an eye on here is the short interest. If you know that more than half of shares on the market are shorted, then the market can enter a Squeeze after even a single high price spike.

Why is Squeeze so dangerous?

Squeeze is not particularly dangerous to the long traders. In fact, it creates an opportunity for them to earn money in just a quick trading session. But the things that make long trading during the Squeeze so lucrative also make it incredibly destructive for short traders.

You should note that the price is growing with an incredible momentum during the Squeeze. It can rise by even 100% and more within just a few days. If you missed the opening of the Squeeze, you may find that it’s impossible to sell your stock back at a low enough price.

If you notice soon enough, you can at least purchase the thing at a market price close to the original value. But if it rises much higher than that, you’ll have to buy the stock at an incredibly high price in order to return a previously cheap stock. The problem here is that short shares have an expiration date (!).

So, unless this massive surge drops back down soon enough, you’ll have no other choice than to buy this extremely overpriced asset.

Saving yourself from a Squeeze

As far as conventional methods go, it’s hard to save your finances when the Squeeze has already started. There are several potential remedies, but the surest one is to avoid trading short altogether. It’s incredibly risky, and you can often earn the same amount of profit from trading long – the usual way.

You can always anticipate the Squeeze. However, it’s not that easy because, as mentioned, they are born from sudden price movements, which means they can’t adequately be predicted. At the same time, you can anticipate that the Short Squeeze may happen if you examine the short interest and how it moves.

Everyone analyzes for themselves, but if you feel that the number is too high (30%, 40%, or even 60%), then it’s a good way to quit the market, while the trend is still bearish. In this environment, a single strong push can give birth to a massive Short Squeeze. It’s particularly dangerous when the percentage keeps rising ever higher.

While it doesn’t happen to all increasingly short markets, it can happen. Whether or not you want to risk possible massive losses over short profits is up to you, however.

The other method is to manage risks. Since the short trades have expiration dates, you can’t keep them forever waiting for the price to get down again. However, the usual stocks don’t have it because they aren’t borrowed. You can keep them forever. This fact alone can help you cap your losses in case of a Squeeze.

It’s true that if you bank on the stock to lose value, buying it the usual way is counterintuitive. However, if the Squeeze comes, your additional shares can suddenly become very valuable. But if they don’t, you can wait until they bounce back up. This only works with shares that aren’t doomed, however. If the trend is hopelessly bearish, though, the Squeeze likely won’t happen.

Alternatively, you can buy a stock from another, more promising company to diversify your portfolio and have something valuable to offset your losses if the Squeeze ruins your perfectly good short trade.

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Written by:


Carolyn Huntington is an economist, professional trader, and analyst. She made her first big deal in her student years with a profitable investment in Facebook stock. Now the total experience of her trade is 18 years. Over the years of trading, Carolyn has developed its own strategy that allows even those who have never traded on the stock exchange before to earn money. She also creates market forecasts and advises major shareholders, compiles investment portfolios, and teaches how to work with automated advisors.

telephone: 503-547-5192