What is a Short Squeeze in Stock Trading?

24 June 2021

A short squeeze is when many people who are shorting a stock are forced to buy it to cut their losses due to a very sudden and strong consolidation of the stock’s price. A short squeeze in the stock market is when millions of short-sellers or very large companies like hedge funds are forced to buy these shares back and return them at a loss.

For example, let’s suppose you have a short position open for Apple. You borrowed it when the price was $100 and you thought it would drop to $80. However, it suddenly starts spiking and reaches $150. Afraid of it growing even further, you bite the bullet, buy the stocks at $150 and return it to whoever you borrowed it from. If you borrowed 10 stocks, that means you sold them for $1000. However, you bought them back at $150 per share, so you spent $1500, meaning you lost $500.

Furthermore, since these short-sellers are now actively buying these stocks to return them to their lenders, it means the stock gets even stronger. Why? Because there are now more people interested in buying this stock, even though they are not going to keep it. It is like a cycle. Price grows, shorters panic, start buying, the price grows ever higher. In the end, we are left with the short-sellers being squeezed out of the market, therefore a short squeeze.

Short Squeeze Indicator - Is There One?

While talking about short squeeze stocks it should be noted that there is no real “indicator” as in an alert system software or anything like that right now. In fact, there is absolutely no telling when a short squeeze may be coming, which is why it’s so devastating to most short-sellers. Nobody can predict it. It can happen any time and any minute without any prior signs in the stock market performance.

On the other hand, there still are some indicators that tell the traders if a shorting position is justified on a specific company or not at a given time. Let’s look at some examples.

Let’s take Tesla stock in late 2019. Almost 18% of the entire Tesla stock was being shorted by individuals and companies alike. That is a HUGE number. All this meant that the market sentiment was extremely negative towards Tesla, and almost everybody was expecting the price to drop, just because of this factor alone. On the other hand, we got sort of an anomaly thanks to heavy-handed marketing from Elon Musk, and in fact, we got a sharp increase in price. This is actually a very good example of a short squeeze in general as well.

However, regardless of this one case, a large chunk of the company’s stock being shorted is a tell-tale sign that they are a goner. This is why a lot of people lose money during a short squeeze.

Short Squeeze Stocks List - Past, Present & Future

Short squeeze means that all of the people who had borrowed the shares in hopes that the stock will go down are now seeing an increase in the share price. It means that every extra cent in which the stock goes up is extra money the traders have to pay in order to get those shares back to the broker. And the worst part about a short squeeze is that it’s a self-fulfilling prophecy in a sense. Why? Well, as the stock price starts growing and some traders start panicking, they try their best to exit their positions. Exiting a short position means to buy the stocks you had sold previously and returning them to the lender. So basically, every short trader is forced to buy the stock they’re shorting, thus pumping the price growth even more. This is one of the reasons why most short traders jump out of the market at the first signs of price growth, as they know it’s going to have a snowball effect.

A short squeeze is not a new phenomenon, it has happened many times before and it will probably happen again in the future. Therefore, it is recommended that traders take a really good look at how these short squeezes happened, what were the major causes, and whether there’s a chance of it happening again but with other company stocks.

Tesla

Tesla is probably the best example of a short squeeze. The time that it takes Tesla to break down its share price tends to be a lot slower than it takes to increase. One of the reasons for this is because Tesla is one of the most shorted stocks in the US stock market.

Tesla sometimes is considered to be the mother of all short squeezes. Since April 2020, there were 20 million shares being shorted and two months later there were 15 million shares. The process of the short squeeze in the stock market was continuing almost during the whole year. This is why a lot of people lost their money at this period of time. The overall amount of money that has been lost during this time reached 38 billion dollars which is an extremely huge number.

GME

Here is what happened in GameStop’s short squeeze. After hitting an all-time low of $2.80 per share in April of 2020 GameStop quickly jumped to $325 per share in January 2021. Almost every hedge fund in the US was shorting this stock, so you can imagine how much damage they took. The stock jumped more than 100 times its lowest price so quickly, there was simply no surviving it. The year-to-date losses on the GME squeeze were around $6.7 billion dollars in total for hedge funds.

Another noticeable thing about this huge short squeeze is that it was like an anomaly in the stock market that has never happened before. Melvin Capital hedge fund decided to place shorting GME stock because they believe that their prices would go down. In fact, the GameStop stock prices did go down for some period of time; however, the Reddit community found out all about these and they started to buy GME stock all at once which caused a price increase in a very short period. All of this became the reason why Melvin Capital lost a huge amount of money eventually.

Herbalife

Herbalife is considered to have one of the most legendary short selling failures in the last decade. This short selling fail saw two hedge fund titans clash and nearly destroy each other: A multi-million dollar smear campaign; insider trading; and an FBI investigation. Bill Ackman's activist short of multi-level marketing firm Herbalife went down in the history books as one of the most disastrous shorts of all time.

Usually epic short selling fails tend to involve high-growth companies where stocks do not conform to traditional models of valuation. Herbalife short selling disaster centers around a multi-level marketing firm. What happened was that in late 2012, Bill Ackman released a research report accusing Herbalife of running a pyramid scheme. He had done extensive research on the company and was convinced that it was a fraud. After that he took a 1 billion position against the company. This eventually led to a drawn-out battle between him and another wall street titan that involved SEC, FBI and insider trading scandals.

Short Squeeze Stocks - Key Takeaways

We discussed that Short squeeze happens when a lot of people who are shorting a stock are forced to buy it in order to cut their losses according to a sudden increase of the stock’s price.
Unfortunately, there is no such thing as a short squeeze indicator that can predict whether a squeeze is on the horizon.

As the stock price goes up, the investors decide it is time to buy back the shares to return them to the brokers, which then causes the price to increase even more.

There are several biggest short squeezes in the US stock market history, the most notable ones include Tesla, GME and Herbalife.

FAQ on Short Squeeze in Stock Market

What is a short squeeze in stock?

Short squeeze in the stock market means that people who are shorting a specific stock are forced to abandon their positions due to a sudden spike in the stock’s price. This forces traders to take on huge losses depending on how much they had invested. And as they abandon their positions and are forced to buy the stocks back, the momentum of the price spike grows, thus dealing even more damage to short sellers.

Is a short squeeze stock good or bad?

Usually, when a short squeeze happens in the stock market, a lot of people lose a huge amount of money which means this phenomenon is definitely not a good thing. For example, when a Tesla short squeeze happened, the overall amount of money that has been lost during this time reached 38 billion dollars which surely is a LOT of money.

The reason why short squeeze is extremely expensive to pay for is because at that moment, every extra cent in which the stock price goes up indicates the extra money that the investor has to pay in order to get the shares back to the broker. This is definitely something that should be avoided however, there is no such thing as a short squeeze indicator that can help traders foresee the near future in order to avoid such big failures and losses in the stock market.

Is a short squeeze legal in stock trading?

There is not precise information about whether a short squeeze is legal in stock trading or not. However, we definitely know that a method to manipulate the price or the supply of the specific stock aiming to cause a shorting in the stock market is truly illegal. This is something that should not be allowed in any type of country or financial market because it causes a number of people to lose a huge amount of money, even millions of dollars sometimes. So if institutions start to manipulate the stock market prices, they will get fined.

However, sometimes the fine is not enough of an obstacle for those institutions who aim to generate a lot of money by causing short squeezes in the stock market. This is why this phenomenon happened and will always happen again in the future.

What happens to a stock after a short squeeze?

After a short squeeze, the stock starts to grow in price. The price growth was what caused the short squeeze, but it then continues due to how shorting works in general. When investors are “squeezed” out of their short positions, they are forced to buy shares and return them to their lenders. Them buying these shares back then adds extra momentum to the price spike making it grow even higher. So, whenever you hear there’s a short squeeze going on, expect a bit more growth to follow.