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A short squeeze is when a stock rises in price quickly and sellers close their positions to avoid a loss.
- Short sellers of a stock borrow shares from their brokers to sell with the aim of buying them back later in order to make a profit.
- When a shorted stock’s price goes up instead of down, sellers can be ordered by their broker to close their positions.
- As the stock price rises, both people who are ‘long’ and ‘short’ buy more shares pushing its price even higher.
What is a short squeeze?
A short squeeze is when the price of a stock goes up instead of down. Shorters of a stock are forced to decide between cutting their losses and buying at a higher price for a loss, or continuing to hold a losing position with the hope of it returning to profit in the future. Sometimes, brokers can demand that shorters close their positions when a stock’s price suddenly increases.
What is a short seller?
A short seller is someone who bets on a stock’s price to fall. To do this, investors need to rent or borrow shares, usually from their broker and sell them on the market. Once a short seller has sold their shares, their aim is to buy them back in the future at a cheap price, while making a profit on the difference.
How do short squeezes happen?
For a short squeeze to happen, a stock must have an unusual number of short sellers holding positions in it. Its price then suddenly rises, forcing the sellers to close their positions. Below is a recent example of a short squeeze that occurred on the company GameStop’s stock.
- A hedge fund called Melvin Capital believed GameStop did not have a good future and decided to go short in the company.
- A group of retail investors noticed an unusually high selling activity in GameStop and responded by going ‘long’, buying lots of shares.
- GameStop’s share price rose very quickly as there were significantly more buyers than sellers.
- Melvin Capital were forced into closing their sell positions and both the investors and hedge funds wanted to buy shares.
- With unprecedented demand, GameStop’s price rose quickly ‘squeezing’ out the short sellers.
Where can I learn more?
Fact-checking & references
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