A short squeeze occurs when a trader goes short but suddenly the cost of the asset goes better than expected. A short position means asset value is expected to go downside. This makes investors exit. That is the reason why such an immediate surge causes losses. However, it’s also possible to take gain from this. A trader should be able to detect such securities and take the beneficial side of the deal.
In this guide, we will try to discover all the important things you should know about short-squeeze securities. This will help you to gain better profits from trading.
Investors bet against a particular stock by short-selling it and are then circumstantially forced to buy back the stocks
at a higher price, to stop further rise to their losses. This happens when the price of any stock starts to rise unexpectedly, which creates havoc among short sellers to quickly buy the stock and close out their positions.
What are the reasons?
The first reason why stocks can suddenly grow in value is a better-than-expected performance of a company. This might be caused by global geopolitical events or just by higher earnings. There are many circumstances under which the demand for some products or services can grow. This leads to a better result for a business and, consequently, the securities go upward in cost.
Let’s imagine a small company with poor performance and revenue is bought by one of the market leaders. In such cases, investors will start considering its stocks more appealing, since they are devalued but might gain better prospects due to the deal.
Often, companies extremely outperform the expectations of investors and analysts in terms of earnings. If a lot of traders short an asset but the corporation surprises everyone with an unpredictably successful earning report, a short squeeze can occur.
It’s important to realize that it can change the situation not only for stock traders. Participants who trade on the foreign exchange can also face them sometimes. The principle of work is similar to one that is applied to stock – a currency that was shorted can unexpectedly turn into a long position.
Although such events happen in different markets, they are more common for stocks.
Is it a long-lasting event?
It’s difficult to answer this question because the duration of such an event depends on a number of factors. The first factor is how many traders shorted a security. It’s also impacted by the liquidity of a product and the announced news. As a rule, a short squeeze doesn’t last for a long period of time.
Often, such price surges last for several days but then the asset’s value goes down again. This happens because the biggest participants don’t want to deal with such volatile securities, and so, they leave.
Can I benefit from such events?
Trading on a short squeeze might be a money-bringing strategy. Nonetheless, there are some aspects that must be taken into account. Before you get down to this, note that trading a short squeeze is a complicated way to gain profits, although the final result may be worth the risks.
No one will provide you with an ultimate guide on how to gain from such volatile events. However, we have several tips on how to turn this technique advantageous. Here are the basic things about trading a short squeeze:
1) Look for shorted assets
Since a short squeeze is more common for the stock market, look for heavily shorted names there. The short interest should be very significant, and you should understand why it is shorted.
2) Study the triggers
A short squeeze will not happen to your asset if there are no big events or other important catalysts to cause it. Look for reasonable triggers that might be catalysts, for example, earnings reports, upcoming macroeconomic changes, or something else of that sort.
It’s important not just to find these triggers but also you need to study them properly. You should understand what they are expected to cause and what they actually can cause. In the stock market, earnings reports are the most common triggers for short squeezes. It’s not difficult to follow because they are released every quarter.
3) Rely on your research and take actions
You have a poor chance to gain profits from a short squeeze if you don’t trust your analysis and hesitate to place a trade. Of course, your research cannot be 100% correct all the time but you shouldn’t be afraid of taking immediate action because some triggers of short squeezes might be very profitable in the long run.
4) Track the Squeeze
Track the squeeze and you will increase your potential gains. Short squeezes might be followed by other important triggers as well.
Final thought
Trading a short squeeze might be a well-rewarded risk if you are attentive to important catalysts and the price fluctuations of your assets. We believe this guide will help understand the basic things about short squeezes work and benefit from them in a real trading environment.
