Everything You Need to Know About Short Squeeze in Stock Trading
In stock trading, we observe unexpected stock prices. Though these high and lows appear random, they tend to have a pattern. One such upward price movement is called a short squeeze. Let’s read more about what it is.
What is a Short Squeeze?
A short squeeze occurs when the value of a stock increases sharply. When market prices increase rapidly in contrast to expectations of analysts and investors, it can hit investors with borrowed shares, as they might end up spending more money to rebuy and return the borrowed stock. This price movement is more likely to occur with stocks that are traded in small numbers or have lower market capitalisation.
If a stock has expensive borrow rates, a short squeeze may happen as it attracts the investors. It also occurs when the demand from short sellers exceeds the supply of shares to borrow, which fails to acquire requests from prime brokers. This often happens with companies that are on the verge of filing for bankruptcy.
The opposite of a short squeeze is the long squeeze. A squeeze can also occur with futures contracts.
Short sales have an expiration date, so when a stock unexpectedly rises in price, the short-sellers may have to act fast to limit their losses.
The flight of short-sellers and their impact on the stock’s price is known as a short squeeze. Short sellers are being squeezed out of their positions, usually at a loss.
Why Does a Short Squeeze Happen?
It may happen due to technical factors or in underlying fundamentals. Lack of supply and an excess of demand can cause a short squeeze. Short-sellers buy stocks that they believe will fall. If the prices rise, the sellers are forced to buy the shares at a higher price to avoid losses, this, in turn, increases the cost of the stock even more. They opt to sell these stocks immediately also if it involves substantial loss.
A short squeeze can be damaging for traders who are shorting stock with derivatives, as derivatives are traded with leverage which can increase your profits as well as your losses. This is especially true when markets behave unexpectedly.
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