Those caught in it liken it to being trapped in a nightmare. You desperately try to wake up but can’t. For those of you who have experienced it, you know what I’m talking about: the dreaded short squeeze stocks. How can one avoid the terror of getting caught in this nightmarish stock market scenario? For starters, it helps to know how to identify stocks that are prime candidates for a short squeeze. But first, let’s start with the basics.
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How to Find Short Squeeze Stocks
Short squeeze stocks are another way to profit in the market. So, how do you find short squeeze stocks? You look closely at a stock’s share counts and calculate the short interest percentage and the short interest ratio.
In other words, you look at the number of shares that have been shorted divided by the number of shares outstanding. The good news is that there are websites or tools that do this for you.
What Does "Short" Mean?
If you’ve been in our live trading room long enough, you’ve probably heard traders say, “I’m long in Facebook.” Translated into simple language, being long in a stock means you outright bought the shares.
So, 100 shares long in Facebook means you own 100 shares. Nothing more, nothing less. But what does being “short” mean? Instead of owning 100 shares of Facebook, you “borrow them” from your broker and sell them “short” on the open market.
Now, why would one ever want to borrow shares? Based on your extensive technical and fundamental analysis, you think the share price will tank.
You aim to sell the shares to a buyer at full price now, hoping the price goes even lower. Essentially, you want to repurchase them at a lower price, return the shares to your broker, and keep the profit for yourself.
Let’s say, “I am short FB,” for example. This means you have sold shares in Facebook (which you don’t own), hoping their stock price will go even lower.
Real-Life Shorting Example
Let’s look no further than Telsa ($TSLA) for proof. In late 2019, investors were betting heavily on TSLA’s failure. Unfortunately, the stock price soared by 400%, and shorts got hammered—meaning they got squeezed.
Overall, they lost close to $8 billion. But that didn’t sway them—so much so that Telsa was the most-shorted stock in early 2020.
In perspective, more than 18% of outstanding Telsa stock was in short positions! Finally, in March of this year, TSLA and the rest of the stock market fell. As a result, short-sellers made close to $50 billion in the sell-off!
Take our online trading courses to learn how to sell the short squeeze on stocks like $TSLA.
What Happens to Short Sellers If Price Rises?
Unfortunately, we are not always right in our stock price predictions. If share prices go up, short-sellers are forced to buy the shares at a higher price—often quickly, frantically.
They then have to pay the difference between the price they shorted and the new price. Our penny stocks list sometimes has stocks to short on it.
What Happens to a Stocks Price After Short Squeeze?
In the stock market, traders always take long or short positions on both sides. When stock prices rise, a short squeeze happens, so sellers must “cover” (repurchase their short position), usually at a loss.
The increasing demand attracts more buyers, which pushes the stock price higher, triggering a feedback loop. This causes even more short-sellers to buy back or cover their positions. And that’s what happens to short-squeeze stocks and the price. Both bulls and bears essentially push the stock price up together.
“The panic of short cover orders and the resulting increase in stock price is known as a short squeeze.” Click here for real-time alerts on some stocks that are short squeezing 🙂
Real-Life Example of a Short Squeeze
For example, let’s say you’ve been following company ABC, and you know they are struggling financially, and bankruptcy news is swirling.
With this tidbit of information, you went short 1000 shares of stock @ \$3.00, at a total cost of \$3000. However, unannounced, they received a financial buyout, which caused the share prices to soar overnight to $4.50. At this point, you’re in the red for $1500. Upon the market opening, you scramble to buy back as many of the 1000 shares at the lowest price possible.
But you can’t get executed. Your blood pressure skyrockets with the rising prices as more and more buyers rush to get in. The endless feedback loop continues as more shorts are squeezed and forced to cover.
When it’s all said and done, shares skyrocketed to $8.00, and you’re on the hook for covering 1000 shares at $8.00. A heart attack is imminent at this point.
Now, I’m being dramatic. You likely could have gotten partially filled, but being caught in a short squeeze is not fun.
Triggers for a Short Squeeze
- Positive news (i.e., drug trials approved)
- New product announcement
- Beating earning expectations
- A tweet from an influential person
- CEO is on CNBC or another news outlet
- A very oversold condition and a historic level of support is tested
Characteristics of Stocks in a Short Squeeze
Did you know that certain characteristics of stocks make them good candidates for a short squeeze? A stock actively shorted with a high short float and days-to-cover ratio is ripe for experiencing a short squeeze.
We have two useful criteria for identifying these stocks: short-interest and short-interest ratios. Short interest is simply the percentage of total short shares outstanding. As noted above, Telsa was at 18%, which was extremely high in the trading world. You can check short interest on any stock over at shortsqueeze.com
Alternatively, the short-interest ratio is calculated by dividing the total number of shares short by the stock’s average trading volume.
The short interest ratio, also called days-to-cover, refers to the number of days it takes for short sellers to buy back all shares that have been sold short. Stable companies tend to have lower short-interest ratios than speculative stocks.
Is a Short Squeeze Good or Bad?
Are short squeeze stocks good or bad? The answer to this depends on who you talk to or what side of the trade you are on. There is the side of the coin that feels like shorting is detrimental to the companies the stocks represent and the stock investors. And then there’s the flip side of traders who can see the downturn coming and profit off that move.
What Does Short-Interest Tell You?
Short interest will tell you if investor sentiment about a company is shifting. We could interpret the short-interest decline (i.e., fewer short positions) as a bullish sentiment. Investors think the company is more stable, or the price has risen too quickly, and shorts got shaken out.
Alternatively, a spike in short interest could indicate bearish sentiment. However, the extremely high short interest could indicate an upcoming short squeeze, increasing the price.
Trading the Short Squeezes
As I mentioned above, many “contrarian investors” buy stocks with heavy short interest to capitalize on their high-potential short squeeze.
Do I dare compare short-sellers to sharks in the water? Think of the short-sellers as sharks swimming around looking for “blood” or overvalued stocks.
But it isn’t without its risks.
There may be good reasons for the high short interest, dismal outlook, and lack of investor confidence; the reasons are endless. A heavy short interest doesn’t mean the stock price will rise. Many stocks that are heavily shorted keep falling in price.
This leads me to another huge risk you must consider: Your unlimited loss potential. For starters, someone who has bought actual stock can only lose 100% of their capital if the stock tanks to \$0.00.
However, someone who has shorted stock can lose more than 100% of their original investment if the price skyrockets. Since there is no ceiling for a stock’s price, it can rise to the moon and beyond.
However, short squeezes can be the bread and butter for momentum day traders. Many will closely monitor these highly shorted stocks and patiently wait for them to rise.
Once the price starts to build momentum, they jump in and buy, hoping to ride the short squeeze wave to the top!
Key Takeaways
- A short squeeze drives a stock’s price up as short-sellers bail out to cut their losses.
- Some traders trade only stocks with a high potential for a short squeeze. To do so, they buy stocks with a substantial short interest.
- Short sales have an expiration date, so be cautious not to be caught having to cover at an undesirable price.
Final Thoughts: Short Squeeze Stocks
Nothing can guarantee the stock you buy, sell, or go short in will move in the direction you want it to. If that were the case, we’d all be millionaires.
To prevent being caught in the short squeeze nightmare, your best bet is to invest in yourself and your education.
Know how to identify the stocks that are setting up and how to read the charts. Know how to enter and exit at the right time.
Frequently Asked Questions
Short squeeze stocks occur when most traders think the stock is going down, but the price shoots up instead.
Gamestop was the biggest short squeeze of all time. Hedge funds were bearish on the stock, but retail traders caused the price to skyrocket, causing many funds to plummet.
Short squeezing isn't illegal. But you can get into trouble if you take too much advantage of those moves and your trading is flagged.
You have to look at the technicals. Don't buy a short squeeze if you don't see anything supporting the price's movement higher.
