"Short Squeezes:What They Are & How to Profit from Them | Motilal Oswal "

What is Short Selling ?

In the share market, there are several categories of investors. Some people are happy trading intraday, while others are short sellers or swing traders, yet others invest consistently and are referred to as contrarian investors. But, one thing is clear in the financial market: every kind of investor is influenced by the investments of others. Since the financial market causes a chain reaction of influencing variables, you must comprehend the terminology that is often used in affecting the financial market.

This post will concentrate on one such term, the Short Squeeze, and how it can help you earn a lot of money. The short squeeze is recognised for significantly boosting the price of an asset, often known as a rally. If you can spot a short squeeze in the time, you can enter a trade and benefit handsomely from the enormous price surge. To comprehend a short squeeze, though, you must first learn about short selling.

Short Selling

It occurs when a short seller borrows stocks from other investors through stockbrokers at current price levels and immediately sells them in the market, earning the selling amount.

Short-sellers wait for the stock price to decline after selling their stocks. Then they acquire the stocks at a reduced market price and sell them to the stockbroker, who then sells them to the investors. Short sellers earn from the difference between the original selling price and the reduced purchasing price. This is how short selling works, and it lies at the heart of the short squeeze phenomena.

What Is A Short Squeeze?

A short squeeze is one of the most unusual stock market scenarios, resulting in an enormous surge in the price of a stock or other tradable instrument. This occurs when a large number of short-sellers have short positions in security and are waiting for the price to fall. The short squeeze always starts when the price of the investment abruptly increases. When this condition is combined with the coincidence of several individuals selling their positions to limit losses, it creates a short squeeze and causes the security price to rise.

Why Do Short Squeezes Happen?

Assume a stock has an unusually high number of short sellers. In such instances, if the security's price climbs by a substantial margin, these short sellers may panic since they know they will lose money if the price rise continues.

Consider identifying stocks with an unusually high number of short-sellers holding holdings.

In such a situation, if any event or reason causes the security's price to rise, it sets off a chain reaction that leads to the short squeeze situation. You must first realise that if the purchasing volume exceeds the selling volume, the price of security climbs further.

When the price of the security increases, short-sellers panic and begin to purchase back the shares they have previously sold to reduce their losses and return them. With the security already having an unusually high number of short sellers, the strong purchasing raises the buying volume, and the security price rises even more. The more the price rises, the more short-sellers purchase the equities to cover their losses, driving up the security price even further.

This causes a chain reaction in which the price rises beginning with the first short-sellers purchasing stocks in fear and continuing until the short-sellers cease buying stocks. Short squeezes are usually caused by panic purchasing by short sellers. Contrarian investors aim to predict and detect a short squeeze and buy equities with a large number of short-selling positions.

Short Squeeze Trading Risk

A short squeeze is an uncommon occurrence, which makes it perilous. There have been countless cases in the past of prices rising when an exceptional amount of short positions were tied to them. But, there have been an equal number of instances when a short squeeze has failed, even when there were exceptionally large associated short-selling holdings. As a result, if you wish to trade a short squeeze, you must exercise extreme caution.

If a security has a high level of short interest, it does not always imply that the price will climb. You must realise that short-sellers do thorough research before engaging in a short transaction. Since the security has a high level of short interest, the price is anticipated to decline. As a result, if you want to trade the short squeeze, you must have additional indicators showing that the security price would climb.

Factors To Think About While Trading Short Squeeze

  • The 'short percentage of the float' is the first thing to consider when trading a short squeeze to assure you are better positioned to reduce risk. It is the proportion of accessible trading securities that are held as short positions.
  • The 'short proportion of the float' should ideally be more than 10%. Only then can the security be classified as having a high level of short interest and being a candidate for a short squeeze. The main rule is that the bigger the 'short percentage of the float,' the more likely it will enter a short squeeze.
  • You should also consider the 'short ratio' or 'days to cover' while trading a short squeeze. It is the total number of days required to produce enough trading volume to repurchase all short-sold securities during the usual trading session. A 'short ratio' of at least 10 days is regarded as optimal, while ten or more days might suggest that security is becoming overcrowded. After recognising the 'short ratio,' you may avoid the transactions unless you wish to be squeezed.

Wrapping Up

A short squeeze is uncommon, but when it occurs, you might benefit handsomely if you are not a short seller. Due to scenarios such as short squeezes, short-selling is considered very risky and may result in massive losses. Before you begin a short trade, you must do comprehensive research on a certain stock. If you are a contrarian investor, you may take advantage of a possible short squeeze by discovering an asset with a high short interest. Nevertheless, it is usually recommended that you trade short squeeze only after thoroughly evaluating the security on other technical or fundamental levels.


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