What Is A Short Squeeze?

understanding a short squeeze

What is a Short Squeeze?

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?

URGENT: Tune into this FREE WEBINAR April 26th, 8pm EST, don’t miss it!

With today’s biggest penny stock runner vTv Therapeutics (VTVT) being the result of a short squeeze I’m getting A TON of questions about this pattern so let me answer them all with this blog post.

But first lets get into understanding a short squeeze.

A short squeeze is what happens when short sellers trigger a rise in price on a heavily shorted stock as in order to close out their short positions, they are forced to buy to cover, creating heavy demand and usually all clamoring to get out as quickly as possible, thus squeezing each other out of their short positions and spiking the stock higher.

Download a PDF version of this post as PDF.

As you can see from VTVT’s morning spike today:

…the stock price can makes 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 ‘squeeze’ comes into play because short-sellers are literally being ‘squeezed’ out of their short positions. And the more that cut their losses and buy to cover their shorts, the bigger the squeeze.

This is all usually triggered by a positive development, particularly on a Friday, 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 tyhe past few years, it’s been pretty a rough time for short sellers and I’ve adapted by mostly going long using this go-to pattern that’s worked surprisingly well.

But even if you don’t like short selling you should most definitely learn about it as it’s good to know all about this catalyst that can REALLY spike a stock…as 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.

That’s the BEST thing to love about a short squeeze, it’s GREAT if you’re holding a long position, so pay attention here, here’s one of the most fundamentally flawed companies in the world, DRYS, and its arguably biggest short squeeze of the past few years as the stock went from single digits to $100+/share in just a few days, and probably could’ve kept going if the SEC didn’t halt it and helped save short sellers galore caught in the squeeze:

The squeeze creates a buying flurry, and you can sell at a sweet profit as short sellers rush to close their positions–with your stock. If you want to make cash on a short squeeze, you have to look for stocks that have a high short interest.

What does that mean? It means stocks who have lots of short sellers who may need someday to cover themselves, although no short selling data is truly accurate or real-time so it’s a VERY imperfect science…use the short data from this tool as it’s the most accurate I’ve found.

Basically, you can bet against the short sellers and win, and it’s not quite as risky as short selling itself, but it’s also tough to judge which short squeezes will really go Supernova.

And of course going long is less risky than short-selling as since shorting involves margin and borrowing shares on a stock that could go wayyyyy 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 would want to bail right awa, rule #1 is 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’s creates gigantic squeezes like DRYS.

And it’s important to remember that short squeezes are more likely to occur in stocks with small market capitalization and a small public float.

Choosing the stocks to play long on an expected short squeeze is the key, 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 the short selling data isn’t very accurate or up-to-date so take this all with a grain of salt:

#1 Time to Cover Ratio

You can get the time-to-cover ratio by taking 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.

#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’s traded on the market. A short interest above 20% is considered high.

If you see a 10%-er, then this is already in the danger zone—meaning, it’s already inching towards 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 average daily trading volume over the last 30 trading days.

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, and put all the cool filters to work for you to find your best short squeeze opportunities, namely by using the social media scanners and seeing which big % gainers have the most people talking smack about as they’re likely short sellers getting crushed and trying to persuade others on social media into also shorting and thus help save them a little…while they usually fail since most short sellers are cynical little trolls, not popular people who can persuade anyone to anything LOL! (trust me I used to mainly be a short sellers so I know them well…thankfully I adapted while I know too many people who can’t adapt and have this gotten wrecked the past few years as shorting is VERY tough unless you have a big account and can risk losing big like this great short seller)

Leave a comment below and let me know if this blog post helped you, I’m always looking for some feedback!