The short squeeze is a phenomenon that has been happening in markets in the last months. Since COVID-19 recovery is on track stocks that went down are rising faster than ever. Due to stocks rising fast, short-sellers tend to be forced to close their selling positions in order to avoid huge losses. This is the so-called Short Squeeze in the financial markets. The strong buying power that gives a sharp rise to stocks “squeezes” the short sellers to get out of the market.
When short sellers experience that the end result is closing the trade on a minus. This causes them to enter a buy position that will put more buy pressure on a stock’s price. Usually traders will do so in order to cover losses and cover their previous position. However, by doing so the stock price is actually fueling more.
As mentioned above, traders take short positions on assets due to their belief that the specific asset might face a downtrend in the upcoming period. Even if their decision has solid proof and is justified well this does not stop a stock from rising if sudden news or fundamentals are out in the market. This can sometimes be, positive earnings reports or expected revenues, or a new partnership or anything that can be positive for a company.
When the stock starts jumping traders tend to panic, especially if this rise shows to continue for days. Their instinct will opt them to close the short position immediately even if it is in a loss. That’s when short squeeze comes in, “forcing” or making a short selling enter the opposite side of a trade meaning opening a buy. This will have a domino effect on short sellers, since they will start entering buy positions one by one supporting the stock price to go even higher!
As of January, the 4th, Tesla has a short interest of $31.20 billion or 44.22 million shares accumulating at 5.83% of its overall positions. In fact, short-sellers in 2019 ended up losing billions on Tesla selling trades and the percentage was up to 18% just last year.
Moreover, Apple Inc. has a short interest of $13.3 billion or 0.6% of its overall positions.
In conclusion, these stocks have barely any short sellers AT THE MOMENT! Make sure you are aware of this next time you think about shorting them because you might end up like the guys in 2019!
Short interest and short-interest ratio are the two most useful measures to understand whether a short squeeze is by the corner or not.
Short interest: Short interest can be calculated by the total number of shares that were short from the total number of outstanding shares. This can be expressed as a percentage, like an example above! Come on, it’s only simple math.
Short-interest ratio: The short-interest ratio is the total number of shares sold short divided by the average daily volume of the specific stock. Stable companies tend to have a lower short interest ratio than the ones that are speculative.
Another thing about short interest is that it can also tell you what the market’s sentiment around a specific asset is. For example, when a company has a 20% short interest and starts decreasing it means that investors or traders have changed their belief regarding the stock. Meaning a buy signal on the horizon, but of course, never place your trades only on sentiment analysis except in extreme cases that volume seems to be catching up. And again, this might be only for a short-term trade!
On the other hand, a rise above 20% indicates that investors or traders have become more bearish on the stock, but extreme fundamental news can force a short squeeze to happen and therefore push the price higher.
Traders tend to think that a stock with a lot of short positions will most of the time benefit them. However, there are many examples of stocks that jumped after they had been heavily shorted.
Note: A heavy short rating on a stock does not mean the price will rise. It just gives a market sentiment of what other traders believe about that stock.
Traders should not buy stock in the belief of short squeeze but should have solid reasons to think that the price of the stock will go up such as better EPS than the previous year, or bullish candlesticks patterns move indicating an uptrend.
Consider a hydrogen fuel cell company, Plug Power, that has a new partnership coming up with a major player such as Renault.
The attitude or behavior of investors around this news would be most of the time positive. Therefore, short sellers will try to catch the stock price at the highest high in order to benefit from a dip after a sharp rise. Let’s say that the short selling on Plug Power is equal to 20% and with day averaging volume of 1 million shares. The short interest ratio will be 5, meaning that traders will have five days to buy back their Plug Power shares that have been sold short. This is why the short-interest ratio is also called days to cover.
Now, let’s assume that the stock’s price has declined due to the heavy short selling from $15 to $5. Then, news comes out about the partnership doing very well and the company has better revenues than expected. All of a sudden, the stock price will jump let’s say back to $15.
All the traders that have shorted the stock and are not expecting good news are now losing on their short positions. They will close it in a loss, in order to catch the rise and cover that loss with a buy position that seems to be attracting more new investors.
Better late than never!
If this has happened to you and you do not know how to act next time, I hope that now you do know that the best decision is made of strong and reliable information. You can also contact our team or join our WhatsApp to be updated live and guided as soon as possible!
