Short squeeze is a situation in which a stock or a short-term commodity moves sharply upward, forcing short sellers to close their short positions and increasing squeeze on the stock. Short sellers are short-sold deals, usually at a loss. Short selling is generally triggered by a positive development that indicates that the stock may start to turn around. Although the shift in stock fortunes may only be temporary, few short sellers can take the risk of a runaway on their short positions and may prefer to close the position even if it means a significant loss.
Short Squeeze Basics
A short squeeze is a risk associated with short selling. If the stock starts to rise quickly, the trend may continue to grow because the sellers will most likely want to exit. For example, if a stock goes up 15% in one day, short position holders may have to liquidate and cover their position by buying the stock. If several short sellers buy back the shares, the price will be pushed up.
Two valuable metrics in identifying stocks subject to short stress are the short interest rate and the short interest rate. Short interest indicates the total number of shares sold short as a percentage of the total shares outstanding. The short-interest ratio is the total number of shares sold short divided by the average daily trading volume per share.
These measures are proper when compared to previous readings in inventory. Since some speculative stocks almost always have a higher short interest than more stable companies, investors look for unusual behavior for a particular stock.
For example, if a stock typically has a short interest of 15% to 30%, any move above or below that range may indicate that investors have changed their view of the company. A fall in the number of short stocks (10%, for example) could mean that the price rose too quickly or that short sellers are leaving the market because it has become flat or bullish. An increase in short interest above the level (35%, for example) indicates that investors are becoming more bearish, but it is also an extreme reading that could lead to a short squeeze and a price hike.
When the interest is very short or at least higher than what is normal for the stock, a short squeeze may result because everyone who wants the stock to fall may have already taken a position. In the example above, if the short interest is 35%, and 30% is already a lot of short-sellers for the stock, then more people than usual have placed their bets on the stock going down. If the stock rises instead because there is no one to sell or sell, the price could rise quickly as a large group of a short-sellers scramble to exit short positions by buying.
How it works for Bitcoin
Traders, investors, and private investors are still licking their wounds from the recent price slide, which swept roughly a trillion dollars off the crypto market in one fell swoop. The Bitcoin price fell from the all-time high of almost $65,000 to below $40,000 today, despite a wealth of positive news from countries that accept Bitcoin as a currency through to institutional investors who make their investments public.
But Bitcoin trading analyzes show that a so-called “short squeeze” could occur: Investors speculate on falling prices, but the price rises, and they have to close their positions by buying, which drives the price up even further.
In the past few months, more and more voices have been raised that blamed “leverage trading” for the high volatility on the crypto market. And admittedly, it is easier than ever to trade with leverage, even for smaller investors. What can be fun when betting in the right direction, but vice versa, has a devastating effect—a risky undertaking, especially in uncertain times.
The reasons to enter into a short position, i.e. to speculate on a falling Bitcoin price, can be varied. Many certainly believe in a “bear market” and long-lasting price declines. From a psychological perspective, too, it makes sense that traders whose stop loss has taken effect, or also investors who may have sold in a panic, now, even more, rely on falling prices.
Viewed historically, an increase in short positions, paradoxically, often indicates an imminent price increase, as happened in November 2020. Leverage trading always carries the threat of liquidation of the positions, which is why many experienced traders advise against it or at least one in unclear market situations. Recommend lower leverage.
What happens in the current situation remains to be seen. However, the fact that the short positions on Bitcoin are reaching a record high is fascinating. We are currently observing another price decline for a few days due to the price increase of the days before. But suppose the recovery continues soon and the price regains the psychologically important mark of $ 40,000 in the long term. In that case, the short positions and their eventual closure will contribute to further price increases.