What is a Short Squeeze? Definition, Markets & Strategies

February 09, 2021 08:54 UTC
Reading time: 23 minutes

In early 2021, a group of online day traders banded together to short squeeze several different markets which resulted in moves on some of those markets of more than 1,000%!

This extraordinary volatility and price movement has thrust the attention towards questions such as ‘what is a short squeeze?’ and ‘how do you short squeeze stocks?’

Read on to find out and learn more!

In this article, you will learn:

The definition of ‘what is a short squeeze?’ and the strategies used to short squeeze stocks. 

Examples of previous short squeezes and the repeated patterns to look for in real-time. This includes the Volkswagen short squeeze in 2008 and the more recent Tesla short squeeze and Silver short squeeze.

How to trade short squeezes using the Admiral Markets Trade.MT5 account to trade stocks, ETFs (exchange traded funds), indices, currencies and commodities via Contracts for Difference (CFDs) which allows you to potentially profit from both rising and falling markets.  

How to supercharge your trading platform to receive actionable trading and investing ideas in real-time market conditions on thousands of different markets using the exclusive Admiral Markets Supreme Edition platform which is FREE to download!

✅ How to access a FREE demo trading account so you can test all the services, features and products for yourself. This means you can trade short squeezes in a virtual environment until you are ready to go live! A great way to hone your skills!

And much, much more!

What is a short squeeze?

To understand the short squeeze meaning, you first need to be familiar with the terms long and short.

▶️ A long position is a situation in which the investor is buying an asset because they believe it will rise over a period of time. 

▶️ A short position is a situation in which the investor is shorting (or selling) an asset because they believe the price will fall over a period of time. 

Example of shorting the market

In a short position, the investor borrows a certain number of shares of a company and then sells it to willing buyers in the open market. If the price of the asset falls in the future, they would then buy the stock back at a lower price and return it to the lender. Essentially, the investor has made a profit from the falling price of the asset. 

Shorting a market is mostly done by larger institutional investors. However, many retail traders can also short as well by using products such as Contracts for Difference (CFDs) which is a derivative of the underlying market being traded. 

In this instance, the trader can use the ‘sell’ button in their trading platform and profit from the potential fall in the market they are trading. Of course, if the market goes up, then they will be losing money. So, how does this help with understanding the short squeeze? Let’s take a look!

Short squeeze definition

A short squeeze is a term that is used to describe a situation where the price of an asset rises sharply, forcing any short sellers to reconsider their positions. As the short seller is now ‘offside’ they are forced to close their positions and buy back their stock to return what they originally borrowed. 

This is also known as short covering, as traders and investors cover their short positions by buying them back in the market. This fuels the rally even higher with the buying pressure causing the short sellers to be squeezed out of the market. As traders close their short positions and buy back the stock in the market, higher prices drive other short sellers to exit their positions as well, generally resulting in a sharp rise in the asset’s price. 

▶️ Short squeeze meaning - A situation when short sellers are forced to exit their positions causing a sharp rise in the asset’s price.  

A short squeeze can actually develop on any market and asset class. You can have a silver short squeeze or you can short squeeze stocks. 

The first step in trying to trade a short squeeze is to make sure you have access to global markets. For example, from the MetaTrader 5 trading platform provided by Admiral Markets you can access more than 3,000+ financial CFD instruments covering global stocks, indices, commodities, currencies and more. 

Start your FREE download today by clicking on the banner below:

What factors cause a short squeeze?

There are many factors which can cause a short squeeze. However, the first defining factor is that the market must be heavily shorted by traders and participants. The longer the market has been falling the more likely there will be more short sellers than buyers. 

Because the majority of the market is shorting the security, any event that causes them to exit the market is likely to create a short squeeze as everyone rushes to exit and buy back their positions in the market. But what can cause this change in thinking? There are a variety of factors, such as:

1. Company specific news 

If a company’s share price is falling, it may attract short sellers who want to profit from the share price falling further. But, if a positive news announcement comes out, such as a great earnings report or an analyst upgrade, it could cause short sellers to rethink their positions and start exiting the market. This is a ripe condition for traders to short squeeze stocks. 

2. Economic or fundamental news

A change in central bank policy can also cause a potential short squeeze in the currency market. For example, if an economy was doing badly, institutional capital would likely flow out of its currency to a currency in which the economy is doing better. This could attract the attention of short sellers who want to profit from a falling price in the currency. 

However, if the central bank starts to change interest rates and gives positive comments regarding the economy it could cause all of the short sellers to exit their positions at the same time. This would cause a rapid rise in prices as they all buy their positions back in the open market - the very definition of a short squeeze. 

3. Technical analysis events

In markets which have been trending lower for quite some time, it is common for traders to trail their stop loss lower as well. The stop loss is the price level in which the trader wants to exit. Short sellers would trail their stop loss down as the market goes down to lock in any profits on any potential swings in the other direction. 

However, if the majority of the market have their stop losses around the same area a news event could easily trigger them. As the stop loss would be a ‘buy’ instruction (to buy back the positions they’ve borrowed to trade short), then the triggering of these stop losses would create a flurry of buying activity resulting in a short squeeze. 

For example, USDJPY had been trending down for most of 2020 and created a long-term trend line resistance. This is an area where sellers kept on stepping in driving the price down but also an area where long-term traders would be moving their stop losses to. 

Source: Admiral Markets MetaTrader 5, USDJPY, Daily - Data range: from 27 May 2020 to 5 Feb 2021, accessed on 5 Feb 2021 at 11:30 am GMT. Please note: Past performance is not a reliable indicator of future results. Last five-year performance: 2020 = -4.89%, 2019 = -0.86%, 2018 = -2.75%, 2017 = -3.70%, 2016 = -2.65%, 2015 = +0.27%. 

Better economic data, a new US president with new policies on handling the coronavirus pandemic and a rise in US bond yields, all gave reasons for sellers to rethink their short positions and exit the market. 

This is evident from the aggressive break to the upside at the trend line (shown by the green box). No new sellers wanted to short at that point and the people who were shorting most likely had their stop losses triggered to buy their positions back in the market and bank their gains from the long-term downtrend. 

Did you know that you can trade the Forex market using Contracts for Difference (CFDs) and speculate on the market going up AND down? Furthermore, you can utilise leverage and control a larger position with a smaller deposit. Learn more and open an account by clicking on the banner below:

4. Social trading buying pressure

A relatively new market phenomenon is the buying pressure that can develop from social trading. As many individuals now share ideas online, there can be instances where enough individuals can band together to put buying pressure on the most heavily shorted companies, forcing short sellers to cover their positions by buying them back in the market, causing a rapid increase in prices. 

For most market veterans it would seem an unlikely scenario enough traders could get together to do so. However, this is what happened in early 2021 when a group of traders from the Reddit forum took aim at the most heavily shorted companies and created significant buying pressure on certain stocks. 

This forced hedge funds who were shorting the companies to buy back their positions creating a huge short squeeze in companies such as Gamestop, Blackberry and Beyond Meat. They even tried a silver short squeeze as well which was heavily shorted by larger institutions.

For example, the chart below shows the Gamestop short squeeze that developed in early 2021. The company, which is a bricks and mortar video game retailer, had been in a long-term down trend since 2013. 

Source: Admiral Markets MetaTrader 5, #GME, Monthly - Data range: from 1 Aug 2013 to 5 Feb 2021, accessed on 5 Feb 2021 at 12:30 pm GMT. Please note: Past performance is not a reliable indicator of future results.

A band of retail traders on the WallStreetBets Reddit forum took advantage of the high short interest in the stock that had built up over the last several years. As they bought the stock, it forced institutional short sellers to the market to exit their investments - otherwise risk further losses on the flurry of buying. Some hedge funds actually collapsed as the stock surged more than 1,000% higher. 

However, what you may notice in the chart above is the rapid fall back down after the initial short squeeze higher. This is one of the classic patterns that can potentially develop after a short squeeze. As short squeeze stocks can move violently on very little reasoning they can also change direction just as quick. Let’s have a look at a few more examples to see what we can learn. 

The Volkswagen short squeeze in 2008 

The share price of car manufacturer Volkswagen experienced some huge price swings in 2008. At one point the company’s share price more than quadrupled in just two days and briefly became the biggest company in the world. 

This is evident from the huge spike higher in its price, as shown in the chart below in the highlighted green box. 

Source: Admiral Markets MetaTrader 5, #VOW, Weekly - Data range: from 7 Aug 2005 to 17 Jan 2010, accessed on 5 Feb 2021 at 13:30 pm GMT. Please note: Past performance is not a reliable indicator of future results.

The Volkswagen short squeeze developed because of a surprise news announcement that Porsche had increased its stake in Volkswagen. This sent a lot of hedge funds, who were shorting Volkswagen shares due to the company’s heavy debt load, to exit their positions causing a huge amount of ‘buying back’ in the market and the subsequent short squeeze. 

What is interesting about the Volkswagen short squeeze in 2008 is that it resembles the Gamestop short squeeze in 2021, when there was a rapid drop in the price after the short squeeze played out. In fact, a month later Volkswagen shares were down around 70% from its high, while Gamestop shares were down 70% just several days after the short squeeze topped out. 

This highlights the importance of using strict risk management techniques and staying up to date with the latest movements in the financial markets. Through the Admiral Markets Spotlight webinar series you can stay up to date with all the latest market news and trading opportunities in this live series, three times a week, where three different traders talk through the markets with you and highlight where the potential opportunities are!

Be sure to register for your FREE spot today, by clicking on the banner below:

The Tesla short squeeze of 2020

Tesla is now the world’s most valuable car company and is worth more than the combined value of General Motors and Ford. What is most interesting is that Tesla was also the world’s most hated company and America’s most shorted stock. 

At one point more than $20 billion of capital was shorting the company’s stock. To put that into perspective, the second most shorted stock in America was Apple at $13 billion. But Apple, at the time, was nearly 15 times bigger than Tesla. 

In October 2019, Tesla reported a blowout quarter for profit when many analysts were forecasting losses. The price of the stock jumped more than 30% in two days and hasn’t looked back since, as the share price below shows:

Source: Admiral Markets MetaTrader 5, #TSLA, Monthly - Data range: from 1 Jun 2010 to 5 Feb 2021, accessed on 5 Feb 2021 at 14:30 pm GMT. Please note: Past performance is not a reliable indicator of future results.

Tesla shares have surged up more than 1,300% since that date. At the same time, the short interest in the stock fell rapidly. In fact, short sellers were forced to buy back more than 38 million shares of the company which amounted to around 20% of all available shares to the public. 

The Tesla short squeeze not only benefited from short sellers exiting their positions but also because of the demand for electric vehicles. The combination of a short squeeze stock on a sector that is in-demand can be very powerful. You can learn more about stock sectors in the ‘11 Stock Market Sectors You Need To Know’ article. 

How to find a short squeeze 

There are different ways to find a market that has the potential for a short squeeze and it mostly depends on the level of information you can access. For example, when trying to short squeeze stocks, investors can find information about the company as it is publicly-listed. In some markets, traders can use technical indicators to help. Let’s have a look at both. 

Using a company’s short interest

One of the best short squeeze indicators for stocks is the ‘short interest’ metric. With publicly-listed companies, you can identify the short interest within it. This metric measures the percentage of shares that are being held by short sellers against the total number of shares of the company. 

If the percentage of shares being shorted increases significantly it makes the stock ripe for a short squeeze. For example, the chart below shows Gamestop’s short interest against the company’s share price. 

Source: Bloomberg, 8 February 2021

From 2017 to 2020 the short interest in the stock rose rapidly, causing the share price to drop at that time. However, what’s noticeable is the Reddit-inspired short squeeze discussed in the earlier section above. 

The short interest in the stock plummeted in early 2021 as retail traders bought the stock in large groups. This forced the short sellers to exit their positions and buy back the stock in the live market, forcing the share price to go even higher in what ended up to be a huge short squeeze. 

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Using technical indicators for short squeezes 

Some traders may use technical trading indicators to help identify oversold market conditions. If a market is too oversold it may cause short sellers to bank their gains causing a rise in prices as they buy back their positions. Oversold conditions may also attract contrarian traders who are trying to trade market reversals which also adds to the buying power causing a short squeeze. 

While there are many different indicators that provide overbought and oversold conditions, one of the most popular is the Relative Strength Index (RSI). This is a momentum indicator that measures the size of recent changes in price to help identify overbought and oversold conditions. 

▶️ The RSI line oscillates between 0 and 100 and is calculated on a ‘user-defined’ period. 

▶️ When the line is above 70, the market is considered overbought.

▶️ When the line is below 30, the market is considered oversold. 

For example, in the weekly price chart of Tesla’s share price below, there have been two occasions where the RSI (14-period) has been at the 30 level and in oversold conditions. 

Source: Admiral Markets MetaTrader 5, #TSLA, Weekly - Data range: from 26 Jun 2011 to 8 Feb 2021, accessed on 8 Feb 2021 at 14:30 pm GMT. Please note: Past performance is not a reliable indicator of future results.  

The two dotted vertical lines and green boxes on the chart show where Tesla’s share price was around the RSI (14-period) oversold 30 level. In both of these cases, the market did eventually push higher afterwards. While this will not always be the case, it does highlight the potential of using an indicator combined with other fundamental analysis of heavily shorted markets and the changing market conditions for short sellers to exit their trades.

Did you know that you can get access to the Technical Insight Lookup Indicator when you upgrade your MetaTrader platform to the Admiral Markets Supreme Edition platform? 

The indicator provides you with real-time, actionable trading ideas across thousands of different instruments. For example, searching for Tesla currently shows 15 different technical events that are taking place in the short-term, intermediate-term and long-term.  

A screenshot showing an example of searching for ‘Tesla’ in the Technical Insight Lookup indicator from the MetaTrader 5 Supreme Edition platform provided by Admiral Markets. 8 February 2021. 

To start your FREE download and get instant access to this indicator, simply click the banner below!

How to trade a short squeeze

Once you have found a market that has the potential for a short squeeze you can trade it by following the steps highlighted below. 

  1. First, open your MetaTrader 5 trading platform provided by Admiral Markets or start your free download here if you haven’t downloaded it yet. 
  2. In the platform, select the View text from the top menu to open the Market Watch window on the left side of your chart. 
  3. In this Market Watch window, right-click and select Symbols. Here you can search from the +3,000 instruments available to trade on via Admiral Markets. Start typing the name of the instrument and a selection of instruments will appear.  
  4. Press OK to add the symbol to your Market Watch list. To view a live chart of the symbol’s price, drag the text of the symbol from the Market Watch window onto the chart. 
  5. To open a trading ticket, right-click on the chart and select Trading and then New Order. A trading ticket will open up for you to input your own entry, stop loss and take profit levels as well as your position size. 

A screenshot showing the MetaTrader 5 trading platform provided by Admiral Markets with a trading ticket open on the chart. 8 February 2021.  

You can learn more about trading a short squeeze in the 39-minute video below on 'How to Trade a Short Squeeze.'

Why trade a short squeeze with Admiral Markets?

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One of the best ways to get started is to open a FREE demo trading account so you can test all of the products, features and services listed above for yourself. 

With a demo trading account, you can buy and sell in a virtual environment until you are ready to go live!

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About Admiral Markets

Admiral Markets is a multi-award winning, globally regulated Forex and CFD broker, offering trading on over 8,000 financial instruments via the world's most popular trading platforms: MetaTrader 4 and MetaTrader 5. Start trading today!

This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or recommendation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.  

Jitanchandra Solanki
Jitanchandra Solanki Financial Markets Author, Admirals London

Jitanchandra is a financial markets author with more than 15 years experience trading currencies, indices and US equities. He is an accredited Market Technician with a BA Hons degree.