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.
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
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
The 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.