Short selling: What it is, why it's risky and how the 'squeeze' happens (2024)

FAQs

Why is short squeeze risky? ›

One big risk is when a bullish catalyst (earnings, news, technical event, etc.) pushes the stock price higher, prompting short sellers to "head for the exits" all at once. As the shorts scramble to buy back and cover their losses, upward momentum can build on itself, causing the stock to move sharply higher.

Short squeeze is a term used to describe a phenomenon in financial markets where a sharp rise in the price of an asset forces traders who previously sold short to close out their positions. The strong buying pressure “squeezes” the short sellers out of the market.

A short squeeze occurs when a stock moves higher and short sellers decide to cover their short positions or are forced to do so via margin calls. As these short sellers buy the stock, the price rises, potentially creating a situation in which more shorts have to cover.

A short squeeze happens when many investors bet against a stock and its price shoots up instead. A short squeeze accelerates a stock's price rise as short sellers bail out to cut their losses. Contrarian investors try to anticipate a short squeeze and buy stocks that demonstrate a strong short interest.

As AMC registers a high of about 26% year-to-date and reaches $5 levels, should the upward trend around the stock be fueled by speculation and socially mobilized investing trends, a large short squeeze is virtually certain in the near term.

A short squeeze occurs when short sellers are forced to close their positions at a higher price. Since they have borrowed shares and are waiting to buy them back at a lower price, the short sell trade falls apart if the price of the underlying stock rises.

Example of a Short Squeeze

Suppose that Company C was borrowed on margin by a trader who then sold 1short 00 shares at $25. Several days later, Company C's stock price plummets to $5 per share, prompting the trader to buy it back. In this case, they earn $2,000 [($25 x 100) - ($5 x 100)].

Depending on the amount of stock shorted, a short squeeze can last anywhere between a few days and a few months. One way to calculate this is through the short interest ratio – dividing a company's shorted stocks by its average daily trading volume.

An epic stock market battle took place in 1901. Two heavyweights fought for control of a railroad, cornered the market, and forced the biggest short squeeze of the last century. The Union Pacific was a railroad nobody wanted to touch, not even J.P. Morgan, in 1898.

What happens when a short squeeze fails? ›

The increase of maintenance margin means more funds must be transferred immediately or the short position must be trimmed down, by buying shares to cover. Failing to meet the maintenance margins can also trigger forced liquidation where the brokerage automatically buys shares at market.

Currently sitting at around $8 a share, a jump to $1000 per share marks an increase of well over 5000%. This kind of growth would require a significant amount of investor confidence and capital to sustain such a high valuation and is highly unlikely in the short and medium term.

The first way to avoid getting squeezed is simply to avoid shorting. But if you do decide to short, make sure you keep your position sizes modest and try to cut your losses early if the trade goes the wrong way. Perhaps most importantly, watch out for highly shorted stocks.

If you short a stock and it then rises in price to the point where the losses exceed the liquidation value of your trading account, you will receive a margin call. At this point, you must deposit more collateral to cover the position. If you don't, the position will be closed and your balance wiped out.

The squeeze creates a positive feedback loop that sends the stock price higher and higher. Short squeezes are somewhat rare. In order for a short squeeze to occur, there must be a large number of short-sellers that together hold a significant number of shares short.

Currently, there are $592 million worth of short positions in AMC, and about 25% of its float is being shorted.

AMC Short Interest Data (2023) AMC's short interest is currently at 24.26%. Because AMC is heavily shorted at 24%, this is a short squeeze play in 2023.

Crucially, according to some market experts, a short squeeze is not necessarily spurred by the percentage of float that is short - 23% in AMC's case - but rather by how much short sellers' money is at stake. Ortex data points out that there are about $746.4 million worth of AMC short positions.

In 2024, many market watchers predict that AMC stock will be worth between $1 and $6. Private retail investors, many of whom aided AMC's significant gain in 2021, are more optimistic, with some projecting a $40 share price.

AMC Short Interest Data (2023)

AMC's short interest is currently at 24.26%.

Does a stock go down after a short squeeze? ›

A stock is shorted when short sellers bet on the stock going down. A short squeeze is a bullish market response. Successful short squeezes can cause short sellers to lose a lot of money. However, this action causes the stock's price to skyrocket.

Con: Short Sellers Risk A Short Squeeze

Because short sellers must first borrow shares of stock from their broker, the broker often has the power to call in the stock or even buy it back on the short seller's behalf if losses on the position grow too large.

When the price of a stock rises swiftly, short-sellers frequently scurry to close out their positions as quickly as possible. A short squeeze occurs when many investors are simultaneously shorting a stock and attempting to exit their positions. An unexpected rise in demand for a stock's shares might increase the price.

When a company's shares are heavily shorted, an up-move in prices can morph into a cascade of short-covering buy orders (often forced by the brokers lending the stocks) that further fuel a vertical rally. This is what is called a “short squeeze.” GameStop will be studied in history as the mother of all short squeezes.

A short seller, who profits by buying the shares to cover her short position at lower prices than the selling prices, can drive the price of a stock lower by selling short a larger number of shares.

If a stock's price rises quickly, then short sellers sometimes scramble to close out their positions as rapidly as possible. A high volume of investors who are shorting a stock and racing to exit their positions at the same time creates a short squeeze.

Search for the stock, click on the Statistics tab, and scroll down to Share Statistics, where you'll find the key information about shorting, including the number of short shares for the company as well as the short ratio.

TORONTO, April 5 (Reuters) - Hedge fund bets against Canada's TD Bank Group (TD.TO) on Wednesday hit $4.2 billion, making it the most-shorted banking stock globally, according to data provider ORTEX's calculations, with some analysts concerned about the bank's exposure to U.S. regional lenders.

Scanning for a Short Squeeze

Essentially, there are three conditions that must be fulfilled: The number of shares short should be greater than five times the average daily volume. The shares short as a percentage of the float should be greater than 10% The number of shares short should be increasing.

Has there ever been a successful short squeeze? ›

One of the most famous, important, and the largest Short Squeezes of the 21 century was a sharp increase in the stock price of a German car maker Volkswagen AG (XETR: VOW) in 2008. On 24-28 October that year, the share price of the company increased by 376.65% from 210.85 to 1005.01 EUR.

One of the biggest price predictions being $1,000. In the past year, some would have laughed at you for your lesser capability to see beyond. What is this? More ambitious short squeeze predictions say AMC can reach upwards of $10,000 per share!

Historical daily share price chart and data for AMC Entertainment Holdings since 2023 adjusted for splits. The latest closing stock price for AMC Entertainment Holdings as of May 04, 2023 is 5.92. The all-time high AMC Entertainment Holdings stock closing price was 62.49 on June 02, 2021.

AMC stock price stood at $5.49

According to the latest long-term forecast, AMC price will hit $10 by the end of 2024 and then $12 by the middle of 2025. AMC will rise to $17 within the year of 2026, $20 in 2027, $25 in 2029 and $30 in 2033.

This is the opposite of a traditional long position where an investor hopes to profit from rising prices. There is no time limit on how long a short sale can or cannot be open for. Thus, a short sale is, by default, held indefinitely.

The broker does receive an amount of interest for lending out the shares and is also paid a commission for providing this service. In the event that the short seller is unable (due to a bankruptcy, for example) to return the shares they borrowed, the broker is responsible for returning the borrowed shares.

With short selling, a seller opens a short position by borrowing shares, usually from a broker-dealer, hoping to buy them back for a profit if the price declines. Shares must be borrowed because you cannot sell shares that do not exist.

A short squeeze is bad news for short sellers and good news for investors going long. The "squeeze" forces short sellers to buy, raising the price of the stock, which causes them to lose money. Investors (buyers) benefit as the stock price goes higher.

Risks of short squeeze trading

During a short squeeze, short sellers run the risk of losing a substantial amount of money if the stock price continues to increase.

How are short squeeze illegal? ›

The rush by short sellers to cover produces additional upward pressure on the price of the stock, which then can cause an even greater squeeze. Although some short squeezes may occur naturally in the market, a scheme to manipulate the price or availability of stock in order to cause a short squeeze is illegal.

Depending on the amount of stock shorted, a short squeeze can last anywhere between a few days and a few months. One way to calculate this is through the short interest ratio – dividing a company's shorted stocks by its average daily trading volume.

Example of a Short Squeeze

Suppose that Company C was borrowed on margin by a trader who then sold 1short 00 shares at $25. Several days later, Company C's stock price plummets to $5 per share, prompting the trader to buy it back. In this case, they earn $2,000 [($25 x 100) - ($5 x 100)].

When a company's shares are heavily shorted, an up-move in prices can morph into a cascade of short-covering buy orders (often forced by the brokers lending the stocks) that further fuel a vertical rally. This is what is called a “short squeeze.” GameStop will be studied in history as the mother of all short squeezes.

Short selling carries significant risks. There is no limit to how high the price of the security can go. If the price of the security rises, the investor must buy it back at a higher price than it was sold for, resulting in a loss. Short selling is most commonly done for speculative and hedging purposes.

Scanning for a Short Squeeze

Essentially, there are three conditions that must be fulfilled: The number of shares short should be greater than five times the average daily volume. The shares short as a percentage of the float should be greater than 10% The number of shares short should be increasing.

If you short a stock at $10, it can't go lower than zero, so you can't make more than $10 per share on the trade. But there's no ceiling on the stock. You can sell it at $10 and then be forced to buy it back at $20 … or $200 … or $2 million. There is no theoretical limit on how high a stock can go.

In January 2021, a short squeeze of the stock of the American video game retailer GameStop (NYSE: GME) and other securities took place, causing major financial consequences for certain hedge funds and large losses for short sellers.