What is a Short Squeeze?

A short squeeze occurs in the stock market when a security’s price rapidly rises, usually in a very short period of time. This rapid rise forces short sellers – investors who profit when the stock’s price falls – to cover their positions, causing further price appreciation and causing the short squeeze.

Understanding Short Selling

Short selling is a process where traders sell a security that doesn’t yet belong to them. They borrow the security from a broker, sell it at the current market price, and hope that they can buy the security later at a lower price. If they do, they have made a profit.

Short squeezes occur when the market starts to rapidly rise, making it difficult or impossible for a trader to buy the security back for a lower price than the one at which it was sold. The trader must then buy the security at a higher price and take a loss on their position. This is when a short squeeze can occur.

Producing a Short Squeeze

Short squeezes are typically the result of either a sustained increase in the price of a security or ‘bear raids’ in which large traders seek to manipulate the market. A bear raid is when a trader or group of traders make trades to artificially deflate the price of a security. This can cause short sellers to panic and rush to cover their positions, which causes an influx of buying and a sharp increase in price.

This is also why a security can move extremely quickly; when short sellers try to cover their positions in a hurry, they often drive up the price of that security.

Conclusion

A short squeeze is an event in the stock market where the price of a security increases rapidly, causing short sellers to cover their positions, creating further appreciation in the security’s price. A short squeeze can be caused by either a sustained increase in the price of the security or bear raids in which traders manipulate the market to cause a price drop. It is important to remember that although a short squeeze can lead to a substantial return, it can also lead to potential losses if the security’s price declines.