How tricky is short squeeze?
Going short is a common practice in the stock market. Traders borrow shares they don't own and then want to sell them again, hoping to do so at a lower price in order to make a profit. However, when the market moves against their position, traders are forced to buy back the shares at a higher price, resulting in losses.
A short squeeze occurs when a significant number of traders have shorted a particular stock, and there is a sudden increase in demand for the shares, leading to a sharp rise in the stock price. This puts pressure on the traders who have shorted the stock, as they are forced to buy back the shares to cover their positions. The rush to buy back the shares further drives up the stock price, creating a self-reinforcing cycle.
Short squeezes can be triggered by a range of factors, such as positive news about the company or an unexpected event that causes a surge in demand for the stock. The key to a short squeeze is that a significant number of short sellers hold a stock, so the demand for the stock far exceeds the supply in the market.
Short squeezes can be very profitable for traders who bought the stock at a lower price because they can sell it at a higher price. However, they can be disastrous for traders who have shorted the shares, as they are forced to buy back the shares at a much higher price than they originally sold them for, resulting in significant losses.
An example of a short squeeze is the GameStop saga which took place in January 2021. A group of retailers on the Reddit forum WallStreetBets noted that hedge funds had heavily shortened GameStop shares. In response, they bought up the stock, driving up the price and creating a short squeeze. This resulted in significant losses for the hedge funds, which had to buy back the shares at much higher prices.
Basically, a short squeeze is a phenomenon that occurs when a significant number of short sellers go short on a particular stock and there is a sudden increase in demand for the stock. This can lead to a sharp rise in the share price, putting short sellers under pressure to buy back the shares at a higher price, resulting in losses. While short squeezes can be profitable for traders who bought the stock, they can be disastrous for those who have shorted them. It is essential for traders to understand the risks of short selling and have a sound trading strategy in place to manage their positions effectively.