Updated on March 10, 2023
A ‘Short Squeeze’ occurs in stock markets when traders’ position goes in the opposite direction of what they had assumed for and then they have to ‘cover for’ or initiate an action or else, get ‘squeezed’, resulting in huge losses.
Short Squeeze Explained
1. Traders generally take short positions in stocks which they think are ‘overvalued’ and assume the prices will go down and thus they can profit by buying them back.
2. However, the prices start moving up, due to strong or positive news related to those stocks or due to a sudden surge in demand.
3. The traders will not be able to buy the stock back at a low price, as it is moving up, in the opposite direction of their position.
4. Thus they will have to either buy more shares at a higher price and pay back to the broker at a loss (in case of leveraged position) or buy more shares at higher prices, hoping to sell them for profit later.
5. The increased buying will still keep moving the prices up. This phenomenon is known as ‘Short Squeeze’.
How to prevent Short Squeeze
Short Squeeze can be prevented to some extent by:
1. Hedging short positions with long positions.
2. Placing appropriate ‘Stop-losses’ or ‘buy-limit’ orders.