Short squeeze

Quick definition

A short squeeze is when a stock rises in price quickly and sellers close their positions to avoid a loss. 

Key details

  • 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. 

  1. A hedge fund called Melvin Capital believed GameStop did not have a good future and decided to go short in the company. 
  2. A group of retail investors noticed an unusually high selling activity in GameStop and responded by going ‘long’, buying lots of shares. 
  3. GameStop’s share price rose very quickly as there were significantly more buyers than sellers. 
  4. Melvin Capital were forced into closing their sell positions and both the investors and hedge funds wanted to buy shares
  5. With unprecedented demand, GameStop’s price rose quickly ‘squeezing’ out the short sellers. 

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Fact-checking & references

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Prash Raval
Financial Writer
When not researching stocks or trading, Prash can be found either on the golf course, walking his dog or teaching his son how to kick a… read more.