A short squeeze occurs when short sellers trigger a rise in price on a heavily shorted stock. It’s a rapid increase in the price of a stock due to a lack of supply and an excess of demand for the stock due to short sellers covering (liquidating) their positions. In order to close out their short positions, the sellers are forced to buy to cover, creating heavy demand.
Should you love short squeezes? Should you fear short squeezes? Should you revere short squeezes? Can you predict short squeezes? What is a short squeeze?
I get these questions all the time.
You might remember vTv Therapeutics (VTVT) being a huge penny stock winner due to a short squeeze. I’ve received a ton of questions about that pattern, and will answer them all here with this blog post.**
But first, let’s get into understanding a short squeeze.
Table of Contents
- 1 What Is a Short Squeeze?
- 2 What Is a Short Position?
- 3 What Is a Long Squeeze?
- 4 Why Try Short Squeeze Trading?
- 5 Short Squeeze Examples
- 6 Short Squeeze Strategy: How to Trade and Profit from a Short Squeeze
- 7 How to Find Short Squeeze Stocks
- 8 How to Come Up With a Short Squeeze List
- 9 The Risks and Rewards of Betting on a Short Squeeze
- 10 The Importance of Professional Trading Assistance
- 11 Frequently Asked Questions About Short Squeeze
- 12 The Bottom Line About Short Squeeze
What Is a Short Squeeze?
A short squeeze occurs when short sellers trigger a rise in price on a heavily shorted stock.
In order to close out their short positions, the sellers are forced to buy to cover, creating heavy demand. Then they usually all clamor to get out as quickly as possible, thus ‘squeezing’ each other out of their short positions and spiking the stock higher.
The stock price can make a huge spike as short sellers close their positions because they think the stock can go even higher — not lower, like they initially believed when they first shorted.
The more who cut their losses and buy to cover their shorts, the bigger the squeeze.
This is all usually triggered by a positive development, particularly on Fridays, when people don’t want to be short going into the weekend when the market is closed, and any positive news can spike the stock even more the following Monday.
As the overall stock market has risen dramatically the past few years, it’s been pretty a rough time for short sellers. I’ve adapted by mostly going long using this go-to pattern that has worked surprisingly well for me.
What Is a Short Position?
A short position means that you’re forecasting a drop in a stock’s price over a given period of time. It’s a way to help make money even if the stock price goes down.
Some people hate shorting because, theoretically, there’s unlimited risk. If the stock defies your forecast and goes up, you might not be able to exit your position until your losses add up substantially.
When you short a stock, you borrow shares in a given stock from your broker at a specific price. Then you buy the stock at a later date for a lower price. It’s a way to sell stock before you buy it, which might seem backward.
Here’s how it looks in the timeline:
- You borrow stocks from your investor at the current price.
- The broker sells the stock on the market and pockets the profit.
- When the stock declines in price, you buy the stocks and return the ones you borrowed.
- You get to keep the difference in price.
Even if you don’t like short selling, you should definitely learn about it, as it’s good to know all about this catalyst that can REALLY spike a stock.
Oddly enough, sometimes the worst companies in the world become the best-performing stocks in the world, and that leaves a lot of people scratching their heads.
What Is a Long Squeeze?
I’ll cover short-squeeze trading in a minute, but right now, I want to talk about a long squeeze. It’s essentially the opposite of a short squeeze because you’re taking a long position.
In other words, you expect the stock to increase in price, so you buy rather than short the stock.
In a long squeeze, investors suddenly feel compelled to sell their stocks because of an event or other catalyst. This creates even more decline in the stock’s price, which gives the advantage to those who shorted the stock.
Remember supply and demand? It’s one of the most important factors contributing to any squeeze.
Let’s say that you have a store that sells smartphones. A new phone comes out and everyone wants it. Your sales go through the roof. Two weeks later, another new phone comes out, and it’s even better than the other one. Suddenly, everyone who bought the first phone wants to sell it back at a loss to get the better phone.
Foreseeing this, the second phone’s manufacturer increased the price to benefit from what they forecasted as a major buying frenzy. Everyone who’s involved in the supply chain makes more money because demand increases.
Then, there’s always someone who wants to game the system. He buys tons of the second phone the day it’s released. When there are no more phones available from retailers, he starts selling the phones online at a steeper rate.
See what I mean? The stock market can be reflected in all sorts of other types of commerce.
Why Try Short Squeeze Trading?
A short squeeze can be great if you’re holding a long position, so pay attention here.
Let’s say you’re looking at a fundamentally flawed company. It’s got terrible management policies, poor sales, no adequate funding — you get the picture.
But it’s arguably one of the best short-squeeze opportunities you can imagine. Let’s say that the company makes a sudden announcement. The stock price goes from single digits to $100+/share in just a few days.
You’re in a possible position to profit from the short sellers in this situation. They all forecasted a drop in stock price because that’s the way the company was heading. Now, the price is shooting up, and short sellers are exiting their positions like crazy and buying to cover.
And who gets to profit from those exiting their short positions? It could be you.
What does that mean? It means there are stocks that have lots of short sellers who may need someday to cover themselves. There’s no such thing as truly accurate or real-time short-selling data, so it’s a VERY imperfect science. I use the short data from StocksToTrade because it’s been the most accurate in my experience.
And, of course, going long is typically less risky than short-selling since shorting involves margin and borrowing shares on a stock that could go way past your initial investment. You could lose more money that’s not even yours (since you borrowed it using margin).
So, if you’re holding a short position, and the price skyrockets, you’ll want to bail right away. Remember, rule number one is to always cut losses quickly, ESPECIALLY as a short seller.
The large number of people/traders/funds exiting their short positions (which is really buying stock at the current price) can push the price up faster and higher than you ever imagined. This squeezes all the other short sellers into doing the same as panic sets in and traders rush to minimize losses — and that creates gigantic squeezes.
It’s also important to know that short squeezes are more likely to occur in stocks with small market capitalization and a small public float.
Short Squeeze Examples
A key factor you’ll also need to consider involves choosing the stocks to play long on an expected short squeeze, and there are certain rules to follow when trying to pick these stocks.
I’ll throw the two most popular ones your way here, but remember that the short-selling data isn’t very accurate or up-to-date.
In other words, do your research and take any data with a grain of salt. Squeezes aren’t the most common scenario, so you don’t want to jump in without being sure about your position.
#1 Time-to-Cover Ratio
You can get the time-to-cover ratio by calculating the total short position (in shares) divided by daily average volume. What does this tell you, exactly? It tells you how bearish or bullish traders are on the stock.
What you’re looking for is a stock that has a cover ratio in the double digits (for days) because these are the big targets for short sellers. A five-day streak in double digit time-to-cover ratio is a good signal.
The reason you consider the total short position and volume is that they’re not good predictors by themselves. For instance, just because there’s a lot of shorted shares doesn’t mean there will be a squeeze — the stock might perform exactly as expected.
Furthermore, volume is just an indication of shares in play; it can’t predict a squeeze by itself.
#2 Short Interest Percentage of Float
Short interest as a percentage of float is a second tool for squeeze-spotting opportunities. The float is the percentage of a company’s stock that traded on the market. A short interest above 20 percent is considered high.
If you see a 10%-er, then this is already in the danger zone — meaning, it’s already inching toward that long opportunity to make money off the short squeeze that’s going to push short sellers out.
The ratio can be calculated by dividing the number of shares sold short by the number of shares outstanding.
I’ll use this example from Investopedia: “If 5 million shares are shorted and there are 20 million tradable (or floated) shares, the short interest is equal to 25%.”
Or, you can forego the math and use StocksToTrade. Put all the cool filters to work for you to find great short-squeeze opportunities, namely by using the social media scanners and seeing which big-percent gainers have the most people talking smack about it because they’re likely short sellers getting crushed and trying to persuade others on social media into also shorting and thus helping save them a little.
Shorting is a dangerous game, and many who use it do it poorly. I’ve managed to evolve my own short-selling strategies to mitigate risk by using large accounts. I’ve also met people who reduce their risk of losing big like this great short seller.
Short Squeeze Strategy: How to Trade and Profit from a Short Squeeze
The idea behind a short squeeze is to take a long position on stocks when short sellers are closing out their positions like crazy. As I mentioned before, there’s usually a catalyst.
Let’s say that a hypothetical oil and gas company was trading at $20 per share. Suddenly, it’s announced that the company might be guilty of patent infringement, which could invalidate much of its assets. Lots of people start shorting the stock as declines to $3 per share.
Two weeks later, after an investigation, it’s determined that the company isn’t guilty of patent infringement at all. The stock price starts to climb as a result of this news, so the short sellers want to close out their positions to mitigate their risks. By going long and start buying up shares, traders could stand to profit, particularly because the short sellers will be accepting lower prices for their shares to cover their margin.
How to Find Short Squeeze Stocks
Finding short-squeeze stocks is no easy task. If it was, everyone would do it.
The major problem with short-squeeze stocks is that there’s an added element of risk. You’re facing extreme volatility in the market as well as information that might or might not be valid — such as the patent infringement example from above.
However, let’s look at how you might find short-squeeze stocks.
Short Squeeze Data
Stock charts can help you pinpoint potential squeeze situations if you watch carefully and align the price movements with information about the company. In other words, you might see a gradual drop in price, but what precipitated it?
In other words, to find short-squeeze stocks, combine fundamental and technical analysis. Relying on just one or the other could result in serious losses.
How to Come Up With a Short Squeeze List
Having a short-squeeze list to watch can make this process — how do I put this gently? — less boring. You’re watching multiple stocks at once, ready to pounce if you see a pattern you like.
At StocksToTrade, you can watch multiple stocks at the same time and use multiple types of charts. It’s also a great place to collect historical data and to look at prior short squeezes that might help you identify patterns later.
The Risks and Rewards of Betting on a Short Squeeze
We’ve already covered supply and demand, but what about risk and reward? There’s always a balance.
The risk here is that you’ll be wrong about your identification of a potential squeeze. It’s not a huge risk, especially if the stock has reached an extreme low, but you could still lose money.
The reward is the profit you could get if the stock moves predictably. However, you have to be able to snap up as many of the shorted shares as possible to make all the effort worth it.
The Importance of Professional Trading Assistance
If you’re anything like me, you enjoy learning by yourself. It can get lonely, though, and you’ll make a lot of mistakes … I know I did.
Today, there are tons of resources and communities out there to help you learn about short-squeeze strategies and other trading opportunities. Finding professional trading assistance can help you identify trading mistakes that can result in huge losses.
Consider applying for my Trading Challenge. It’s part education, part community, and part watching other people (including me) trade. I share every trade I make and provide extensive commentary so you can understand the reasoning behind my decisions.
Frequently Asked Questions About Short Squeeze
What is a Short Squeeze?
A short squeeze happens when short sellers inadvertently create a price increase on a heavily shorted stock.
What causes a short squeeze?
A short squeeze is caused by too many traders trying to short a stock. To close out positions, they’re forced to buy to cover — the “squeeze” refers to the many traders trying to exit at once, which can drive the price even higher.
What is a Short Position?
A short position refers to short selling a stock. As a short seller, you believe the stock price will go down in value. The process of short selling involves borrowing shares, selling them, and buying them back, ideally at a lower price, and keeping the price difference as profit.
How to Find Short Squeeze Stocks?
Finding short squeeze stocks frequires fundamental and technical analysis. My advice? Start by observing how short squeezes play out, then begin adding stocks to your watchlist that have similar characteristics.
The Bottom Line About Short Squeeze
A short squeeze opens up a whole new way to potentially profit in the stock market, but it’s far from a guaranteed win. Practice with small positions at first so you’re not risking a large portion of your trading account.
Have you ever tried the short-squeeze method? How did it work out for you?