What is a Short Squeeze in the Stock Market?

Definition of a Short Squeeze

A condition in which the heavily shorted commodity or stock, moves higher forcing the short sellers to close out their position which adds pressure to the stock. A short squeeze means that the short sellers are squeezed out of their short positions at a loss. A short squeeze may trigger positive development because the stock might increase in value. At this position, some short sellers prefer buying the stocks back at a higher price compared to the price they sold the stock to avoid further losses.Short-squeeze

Understanding Short Squeezes

A short seller borrows the stock through the margin account if a stock is overvalued. They then sell the stock with the hope that the price of the stock will go down. The proceeds are then held in the margin account as collateral. Eventually, the stock seller buys the stock back what is referred to as buyback. If the prices of the stocks which the seller sold go low, the stock seller makes more money. The money earned is the difference between reduced stock price that is paid later and stock sold on margin. However, if the price of stock sold goes higher, the seller makes a loss.

Three ways of predicting short squeezes

Short interest ratio

stock-market

This refers to the short interest divided by the average daily trading volume of the stock that one wants to sell. For example, if you take 300,000 shares of short stock than dividing it by an average daily trading of 30,000, it will take ten days for the short sellers to buy back the shares. A higher ratio means that there is a higher likelihood for the short sellers to drive the price up. A short interest of 10 days, is an indication that the short sellers might panic, and it is the best time for the sellers to purchase a short squeeze.

Short interest percentage

It refers to the number of shares outstanding divided by the shorted shares. For example, if there are 20,000 shares which are sold by short sellers, and 200,000 shares outstanding, the short interest will be 10%. A higher percentage means that the short sellers will be competing against each other to buy the stock back if the price of the stock continues to rise.

Daily moving average charts

Stock-Market-TradingThe daily moving charts illustrate where the stock has traded within a particular period. When you look at a 50-day moving average chart, one knows whether there is a rise in the stock’s price. There are various charting software programs available that can help one to plot your chosen stock. Getting information from news article helps one to know whether a short squeeze will occur. Thus, staying informed in your stock’s field is an important aspect that one should always consider.

The bottom line is that the success of a short squeeze depends on the ability to sell your stock during the peak season. Employing a short squeeze is risky, but the risk can be reduced by observing the industry trade, and focusing on predictors discussed above which are daily moving averages, short interest ratio, and short interest percentage.

What is Short Selling?

Short selling is an amazing concept. You will be selling a stock or any kind of financial instrument that you have just borrowed so that you can make a sale. This is truly awesome, but you need to get more information about this right away. So read on.

Traders like Tim Sykes have popularized short selling, but new traders don’t always know how to get started.

What-is-Short-Selling

Liquidity in the Stock Market

A short seller will provide liquidity to the financial markets restraining any influence about the exuberance of investors over time. They should not be seen as cynics trying to pry on other people`s mistakes but rather they should be treated as legitimate players in the investment world. Short selling is good for the market because it prevents any stock from getting too high down the road during peak time. Short selling is perilous in any surging market out there.

What-is-Short-Selling

Example
The short-selling process can be easily illustrated using a real-world example. To short any kind of stock, you will need to open a margin account at any brokerage firm out there. This will allow you to have fun in no time. You will need a certain amount of money to open this account so you can have some margin. Let`s say that you want to sell a hundred shares of a $10 stock. You will have to put in $500 as your account`s margin.

Common Short Sellers

Hedge funds are some of the most important investors in the world of short selling. If a hedge fund considers that a sector or stock is overvalued, they will use short selling so they can hedge this risk of the market. Sophisticated investors love short selling. They use short selling so they can speculate or hedge market risk over time. Speculators also play the short selling game from time to time, and they love it.

Short Selling Regulation

What-is-Short-Selling

The uptick rule was imposed to the short selling world. This rule was created to avoid short seller from exacerbating any downward movement of a stock when the financial instrument was declining. In 2007, the SEC just ruled out this rule. Some experts in the short selling field believe that this action contributes somehow to the development of the market volatility and bear market of the years 2008 and 2009. In 2010, the SEC adopted what was called an alternative uptick rule.

Rewards and Risks

You can think of short selling as a kind of insurance for the world of financial markets. Let`s give you another example. Say you have a bought the S&P 500 index via a mutual fund. Say also that you have a short selling position for this index. If the market falls at a certain point in the future, you can make good money down the road. This is probably what will happen over time.

Remember that short selling is truly here to stay for the long run because it provides real liquidity to the market. This is truly important for the stock market because of the problems caused by downward trends in many stocks out there. There is some kind of regulation regarding short selling, but this will not prevent hedge funds and speculators from having fun and making profits via this amazing concept these days.