A short squeeze is a situation in the stock market where the price of any stock starts increasing rapidly due to short position shifts of short-sellers. This leads new investors to attract to the increasing stock price, which in turn makes them invest in those stocks. As a result, the price of the stock increases suddenly which is termed as a short squeeze. Short squeeze generally occurs in those stocks which have a large percentage of stock float in shorts.
Understanding Short Squeeze
To understand this term, we need to first understand who are short-sellers. Short sellers are basically investors who borrow the securities from the broker believing that the share price of the stake will decrease in near time. Now they will sell these stocks at the present market price to the other investors. Once the share price decreases, they will purchase the same amount of securities from the stock market at a lower price and will return it to the broker. This is how they will profit.
But if the share price of the stock never decreases and starts increasing, these short sellers will start panicking and will start purchasing the stocks at a higher price. This price is generally greater than the price they have sold the stocks that they borrowed. To minimize their losses, short sellers start to change their positions rapidly causing an increase in demand for the stocks. This will in turn increase the share price. Again, this sudden increase in share price attracts normal retail investors to purchase the stocks of that company. This situation in which the stock price of a company increases rapidly due to the involvement of retail investors and short sellers is called a short squeeze.
Short Squeeze vs Long Squeeze
As we already know what a short squeeze is; just the opposite is the long squeeze. A long squeeze is a scenario in which the stocks of any company start to fall rapidly. This usually happens when an investor who has long positions feels squeezed when the price of stocks starts to fall. To minimize the loss of their long-held stocks, these investors tend to sell their stocks resulting in even more drop in stock prices termed as long squeeze.
Short Squeeze vs Gamma Squeeze
While a long squeeze is the rapid fall of stock price, a gamma squeeze is like a short squeeze in which the price of stocks rises quickly. But the cause of gamma squeeze is different. The gamma squeeze occurs when there are too many options trading especially “call” options trading at the same time. The call option is traded between the options trader and the market maker. Once thousands of call options are traded, the price of the stock starts to rise. In this situation, the market maker who sold the stocks when the call option was traded, feels that they have lost money. So to overcome this loss, market makers also start to purchase the stock, resulting in even more price hikes of the stocks which is called a gamma squeeze.
Risk of a short squeeze
The risk depends on whether you are a short seller or a retail investor. If you are a short seller and a short squeeze happens, you are at maximum risk of losing a huge amount of money. But if you are a retail investor who already has stocks of the company that is undergoing a squeeze, then you might get profited a lot cause the price will rise rapidly.
Another consideration is that any stock that undergoes a short squeeze or gamma squeeze, once they have reached the maximum point then the price will start to fall rapidly. You always need to be sure that the downfall might come at any time and should be ready to sell your stocks in time.
Short Squeeze Investment Guide
Short Squeeze may last up to days based on how big the company is. Recently Elon Musk’s Tesla stocks (NASDAQ: TSLA) soared up to $1,800 within days from a market price of around $220. Those who are holding a long position should not try to sell in an early short squeeze. As you may never know how long the squeeze is going to be.
If you are a short seller, you need to be very active in stock exchange platforms such as NYSE or NASDAQ to be ready to purchase stocks. Because if you are not ready to purchase stocks at an early stage, you might lose a lot. As per research, during the short squeeze short-sellers have lost around 40 billion dollars in the TSLA short squeeze.
If you are just a retail investor and you do not have any stocks of that company then the best bet would be to analyze the market first. What it means is that you need to visualize the market performance of the last 52 weeks and see what the curve is going to be. In short, the curve is going to be parabolic. i.e. it will rise continuously and will fall continuously to make a parabolic shape. Just don’t try to invest in the early or mid of the parabolic curve but with caution that it might fall soon.
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