Trading a Short Squeeze

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Putting pressure on short sellers.

All stock investors feel pressure when they are investing. Most investors feel that pressure when stock prices are going down, but short sellers are a little different. Short sellers feel pressure when stock prices are going up.

Video: Understanding Short Squeezes

After all, short sellers make money when stocks are going down, and they lose money when stocks are going up.

How Do Short Sellers Get Squeezed?

Short sellers get squeezed when the price of the stock they have shorted begins to rise. This can happen because investors are feeling good about the stock and more and more are starting to add it to their portfolios, because some investors who sold the stock short are exiting their trades and covering their positions or a combination of both.

As the stock price rises, it either eats into a short seller’s profits or increases a short seller’s losses. Either way, the experience is unpleasant.

Plus, short sellers are usually in a leveraged position because they have borrowed the stock they have shorted from their broker. This means the pressure that comes from mounting losses is amplified.

What Happens When Short Sellers Get Squeezed?

When short sellers get squeezed, they try to minimize their losses by exiting their trades. To do so, short sellers have to go out into the market and buy back the shares of the stocks that they shorted. This added buying pressure continues to push the value of the stock higher, which leads to further pain for the remaining short sellers.

Soon enough, these short sellers begin to exit their trades by covering their short positions, and the cycle begins to feed on itself in a feedback loop that pushes the price of the stocks higher and higher.

Watching for Short Squeezes

If you want to find potential short-squeeze candidates, keep your eye on the short-interest levels of stocks that have been losing value. If the short-interest levels are high, watch for little turn arounds and signs of life. If the stock price begins to turn around, you may see a short squeeze in the making.