In general, the higher a stock’s days-to-cover figure, the more susceptible it may be to a short squeeze. If days to cover for stock A and stock B are two days and 20 days, respectively, then stock B may be more vulnerable as a short squeeze target. If the shares of NoGood instead increase in price, then the short seller is at risk of losing a very large amount of money on the trade. A high volume of investors who are shorting a stock and racing to exit their positions at the same time creates a short squeeze. The sudden surge in demand to buy shares of a stock can send the stock’s price even higher. For example, Investor A borrows 10 shares of Company Z at $5 per share.
- Investing involves risk including the potential loss of principal.
- Then, the news comes out that Medicom’s drug works better than expected.
- The surest way to avoid getting caught up in a short squeeze is to refrain from short selling entirely.
The investing information provided on this page is for educational purposes only. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments. The stock market crash of 1929 caused a financial frenzy in the United States. The first bank runs occurred in the fall of 1930 in Nashville, when account holders rushed to withdraw all of their funds at once from the bank. Quickly, this credit squeeze spread across the U.S., causing many banks to liquidate their loans to appease their depositors, leading to multiple bank failures. New York’s Bank of the United States had more than $200 million in deposits at the time when it collapsed in 1931, making it the largest bank failure in American history up to that time.
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It’s important to note that buying pressure alone may not be a substantial indicator that a short squeeze will occur, but it may be used in support of other indicators. During this time, day trading and individual investing had increased, and the news of this potential bull case had circulated. There was also heightened interest in GameStop in spaces such as WallStreetBets (a Reddit forum), which had pegged GameStop as an undervalued stock for some time.
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If the stock’s price has dropped, the short seller makes money due to the difference between the price of the stock sold on margin and the reduced stock price paid later. However, if the price goes up, the buyback price could rise beyond the original sale price, and the short seller will have to sell it quickly to avoid even greater losses. If, for example, NoGood Co. reported better-than-expected earnings and its stock price jumped to $120, then panicked short-sellers might rush to close out their positions before the share price kept climbing. This sudden high demand could cause the stock’s price to rise even more sharply to $130 or $140 per share. The dramatic jump in price “squeezes” those who shorted the stock. This unexpected rise in the share price can signal to other short-sellers to exit the short, further driving the price up.
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. The stock reached a pre-market value of more than $500 per share, which had multiplied over 30 times since https://traderoom.info/ its starting stock price of $17.25. 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.
How does a short squeeze happen?
The term squeeze is used liberally in finance and business and describes various situations in which people are realizing losses, taking gains, or finding credit difficult to obtain. Several types of squeezes—including profit squeezes, credit squeezes, short squeezes, long squeezes, and bear squeezes—are explained below. Squeeze situations are often accompanied by feedback loops that can make a bad situation worse due to market psychology.
We do not endorse any third parties referenced within the article. Market and economic views are subject to change without notice and may be untimely when presented here. Do not infer or assume that any securities, sectors or markets described in this article were or will be profitable. Historical or hypothetical performance results are presented for illustrative purposes only. There are various indicators that investors may use when predicting an upcoming short squeeze. Some of those indicators may be short interest, days to cover or the short interest ratio, buying pressure, and the relative strength index (RSI).
What is a short squeeze? Understanding why they happen and how they work
Therefore, there’s no limit to the price the short seller could pay to buy back the stock. Before you can understand short squeezes, you have to understand how short selling works. The Charles Schwab Corporation provides a full range of brokerage, banking and financial advisory services through its operating subsidiaries.
Where Can I Find Information on Stocks with High Short Interest?
In spectacular situations, however, the stock may rise times in value, sometimes over just a few days. These situations are sometimes called the “mother of all short squeezes” and they can be tremendously lucrative for long investors and ruinous for short sellers. One of the most famous recent examples of a short squeeze was the massive rise of GameStop stock in 2021. 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. This is where the short squeezer comes in and buys the stock—while the panic-stricken short sellers are causing a further rise in price due to short-term demand.
A short squeeze is a high-risk situation and it may cause havoc in the market, but most don’t last forever. Identifying a short squeeze can be relatively simple—after the fact. The trick is to identify the conditions that could lead to a squeeze ahead of time, and then determine how you might want to play it (or not). A positive news story, a product announcement, or an earnings beat that excites the interest of buyers can defeat a short position. Plug Power Inc PLUG stock has been treading south for most of the past year, with stock down over 74% during that period.
Since many traders are short, they would need to cover their short positions to limit their losses; this creates buying pressure on the stock and causes the price to increase to $80. The process of a short squeeze unfolds when a stock’s price begins to climb, compelling short sellers to buy back the stock to cover their positions and mitigate their losses. This rush of buying activity elevates demand, propelling the price even higher, thus catalyzing a squeeze. If short sellers are mistaken and the business is not overvalued or impaired, going long could be quite profitable. 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.
A short squeezer must not only learn to predict and identify short squeezes, but also pick the right time to sell the stock, which is at or near its peak. When a stock’s price starts to rise rapidly, short sellers want out, because they only profit when the stock goes down. Naked shorting still happens thanks to discrepancies between electronic and paper trading. Naked shorting can help exacerbate short squeezes by allowing for additional shorting that otherwise might not exist. That is, naked shorting can force a price drop, which leads to some share sales to cut losses, allowing the market to effectively find balance. Contrarian investors may buy stocks with heavy short interest to exploit the potential for a short squeeze.