Short Squeeze: Meaning, Overview, and FAQs - Earnplify


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Short Squeeze: Meaning, Overview, and FAQs

February 1, 2023

One of the most famous recent examples of a short squeeze was the massive rise of GameStop stock in 2021. During a short squeeze, short sellers run the risk of losing a substantial amount of money if the stock price continues to increase. In addition, a large short interest can go either way, meaning that the stock price can still increase just as much as it can decrease. Short interest is an indicator that certain investors believe that the stock price will decline. Since a short seller’s buying decision for a stock makes a stock’s price increase, this ultimately leads to other short sellers buying to exit the position. In addition, a stock’s price increase may also encourage regular buyers to invest in the stock with the belief that the stock’s value will continue to increase.

The short interest had grown so dramatically that it amounted to more than 100% of the shares outstanding. When a heavily shorted stock unexpectedly rises in price, the short sellers may have to act fast to limit their losses. Short sellers borrow shares of an asset that they believe will drop in price in order to buy them after they fall. If they’re right, they return the shares and pocket the difference between the price when they initiated the short and the price when they buy the shares back to close out the short position.

  1. When Porsche announced a takeover of Volkswagen in October 2008, short-sellers scrambled and prices soared.
  2. In January 2021, a post on a page of the online forum Reddit’s subreddit channel r/wallstreetbets caused a short squeeze of the video game retailer GameStop’s stock.
  3. Suppose that Company C was borrowed on margin by a trader who then sold 1short 00 shares at $25.
  4. Exchanges such as the New York Stock Exchange and the Nasdaq also publish short interest data for the exchanges as a whole.

When a short seller decides to sell the security, it’s called short selling. Short selling is when a short seller predicts that the value of a stock will decrease. To profit, the short seller will borrow the stock from their brokerage to sell and then purchase the stock back later at a lower price. If all goes as planned, the difference between what the short seller sold the stock for and the amount that they bought it back for becomes their profit. If the short seller’s prediction is wrong, and the stock’s value increases, it forces them to buy the stock back at a higher price from which it was sold, and pay for the difference. In simpler terms, just remember that short selling is a way for short sellers to make a quick profit by borrowing a stock or security to sell and then buying it back to possibly profit and return the stock.

Where Can I Find Information on Stocks with High Short Interest?

A short squeeze often contributes to market volatility and implies rapid, significant price changes. For instance, the GameStop saga stirred significant swings within its own stock price and the broader market, influencing the performance of other stocks and sectors. It had a significant impact that caused many to earn money very quickly while it caused hedge funds, like Melvin Capital, to lose nearly $7 billion in as quickly as a month.

The first phase of short selling is to sell the stock, and the second phase (which is mandatory) is to buy the borrowed stock back to return the stock to its original owner. In the case of TSLA in 2020, there were some positive fundamentals underlying the short squeeze, including the company’s more consistent profitability and hopes of it being included in the S&P 500 Index (SPX). The stock saw its share price run up to new highs, then decline nearly 60%. Companies valued between $100 million and $8 billion (known as small-cap stocks) are good candidates to be shorted, as are stocks with high short interest, or a high percentage of stock shares held by short-sellers. If the stock price rises instead, a short-seller may lose money — they still have to return the shares to the broker, which may require buying them back at the new higher price. But if it’s not, short sellers can face runaway losses as the expiration date on their positions approaches.

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Investors can also bet on a short squeeze by buying a stock with high short interest as it starts to rise. The initial increase in the stock price could lead to a short squeeze if it continues, sending the price higher and higher. A short squeeze is a sudden increase in the price of a stock due to a large number of short-sellers buying shares to cover their positions. As recently as September 2020, GameStop traded for less than $2 a share (split-adjusted). It slowly gathered momentum through the end of the year and started 2021 at more than $4 per share. Many investors thought the company was going broke and invested accordingly.

Betting on a Short Squeeze

One short seller had a huge position in the stock, and short interest was greater than the number of shares of outstanding stock. One of the most notable short squeezes in recent history centers on the stock of European automaker Volkswagen (VWAGY -0.14%). In 2008, Volkswagen saw its stock price jump by more than 300% in a matter of days, briefly making the company seemingly worth more than $400 billion — above the valuation how to start a mortgage brokerage in 2023 of any other public company at the time. The relative strength index (RSI) measures the extent of price changes to determine overbought or oversold conditions in the stock market. A low RSI means that a stock is oversold and is trading at a low price, while a high RSI means that a stock is overbought and is trading at a high price. An RSI below 30 means that the stock’s price will increase, which can signal a short squeeze.

A short interest ratio of five or better is a good indicator that short sellers might panic, and this may be a good time to try to trade a potential short squeeze. Suppose that Company C was borrowed on margin by a trader who then sold 1short 00 shares at $25. Several days later, Company C’s stock price plummets to $5 per share, prompting the trader to buy it back. However, if the stock price increases, the short seller is still liable for the price of the stock when it is sold. So, if the trader buys back the stock at $30 instead of $5 (as in the example above), the loss is $5 per share, or $500. When there’s a short squeeze, naked short selling essentially creates phantom shares, increasing liquidity in the shorted stock.

What is a short squeeze?

This normally happens because investors place a stop-loss order to mitigate risk and ensure they are protected against any price declines. When an investor decides to short a stock, they are betting that the price will decline in the short term. But if the opposite occurs, the only way for them to close their position is to go long by purchasing shares of the stock. This can cause the stock’s price to further increase, resulting in further action by short sellers. GameStop’s stock price surged due to a short squeeze on major hedge funds that were short the stock and forced to sell to cut losses.

Closing Market Update

This rush of buying activity elevates demand, propelling the price even higher, thus catalyzing a squeeze. Treasury Accounts.Investing services in treasury accounts offering 6 month US Treasury Bills on the Public platform are through Jiko Securities, Inc. (“JSI”), a registered broker-dealer and member of FINRA & SIPC. See JSI’s FINRA BrokerCheck and Form CRS for further information.JSI uses funds from your Treasury Account to purchase T-bills in increments of $100 “par value” (the T-bill’s value at maturity). The value of T-bills fluctuate and investors may receive more or less than their original investments if sold prior to maturity.

The offers that appear on this site are from companies that compensate us. But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you. Holding company Porsche SE owned a big chunk of the shares, and the German government also owned a large stake, meaning that relatively few shares were actually traded in the public market. There was ample speculation that Porsche would buy the rest of Volkswagen. It’s important to always do your homework, and remember it’s never wise to go all in.

However sound their reasoning, a positive news story, a product announcement, or an earnings beat that excites the interest of buyers can upend this. But what if there are many short sellers who want to buy back shares before they lose even more money as the stock rises? Therefore, there’s no limit to the price the short seller could pay to buy back the stock. Another important metric to look at when trying to identify stocks where a short squeeze may occur is the short-interest ratio. It weighs the amount of short interest against the stock’s average daily trading volume. Transitioning from how a short squeeze operates to understanding its implications, it’s noticeable that short squeezes can lead to considerable price swings.

If they’re wrong, they’re forced to buy at a higher price and pay the difference between the price they set and its sale price. The short interest ratio is the short interest divided by the average daily trading volume (ADTV) of the stock in question. For instance, if you take 200,000 shares of short stock and divide it by an ADTV of 40,000 shares, it would take five days for the short sellers to buy back their shares. If a short seller thinks a stock is overvalued and shares are likely to drop in price, they can borrow the stock through a margin account. The short seller will then sell the stock and hold onto the proceeds in the margin account as collateral.

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