Everything you need to know about the short squeeze

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If you have heard of the short squeeze but are unsure as to whether or not you should love it, whether you should fear it, or whether you should revere it altogether then you should read on and learn more about what exactly it is.

One example of a successful winner as a result of a short squeeze was the clinical-stage biopharmaceutical company vTv Therapeutics. To be able to replicate such a profitable trade, you must first understand exactly what a short squeeze is.

A short squeeze – What exactly is it?

This occurs when traders selling short cause a rise in the value of a stock that is heavily shorted. To close their short position, traders buy in order to cover, thus creating a large demand. These traders all aim to get out of their position as fast as possible, squeezing each other and thus raising the price of the stock.

The stock’s price usually makes a considerable spike as traders close as they think that it is likely that the value of the stock can rise even further. This is opposite to their original predication where they believed the price of the stock would go down. The more traders that do this to minimize their losses, the bigger the squeeze is.

This activity is typically triggered by positive news relating to the stock, and usually occurs on a Friday when traders do not want to go into the weekend in a short position when the markets are closed. A positive news announcement can bolster the price of the stock even further on Monday.

On the whole, short-sellers have had a pretty rough time over the past few years with the overall stock market rising.

How to have a short position

Having a short position means that you are essentially anticipating that there will be a drop in the price of the stock during a given period. It means if the price of the stock falls your profit.

Some traders oppose those who short sell, as there is an unlimited risk in the practice of it, theoretically at least. If the stock goes against what you anticipated and increases in price, a trader may not be able to get out until their losses have mounted up significantly.

When shorting a stock, you must borrow shares in a stock from a brokerage firm for a specific price. You then buy back the stock at a later date at, hopefully, a lower price. It is a method of selling the stock before actually buying it. This seems quite backward compared to how trading usually works.

Here is how a timeline of events work; the trader lends stocks from a brokerage firm at whatever the current price of that stock is; the brokerage firm then sells the stock and keeps the profit; when the price of the stock goes down, the trader buys the stock back and returns the ones borrowed. The trader keeps the price difference.

Even if the idea of short selling does not appeal to you, it is something that should definitely be learnt. After all, it is useful to understand the catalysts that can boost the price of a stock.

It can sometimes be the case that it is the worst-performing companies that actually become the ones whose stocks perform the best. This obviously leaves a lot of people puzzled as to why.

Why should you try short squeeze trading?

A short squeeze can be beneficial to those traders who hold a long position. For example, imagine looking at a poor performing and flawed company that has inadequate management, is underperforming, and lacks funding.

However, it is a great opportunity for a short squeeze. Now imagine this company makes an announcement and the price of the stock goes up significantly to over $100 per share within just a couple of days. In this position, you are able to potentially profit from short sellers who are anticipating a fall in the price of the stock because the company is performing and will continue to perform so poorly.

If the price of the stock goes up, short sellers will begin to exit their position on mass and buy to cover. It is at this precise time that you could benefit from the actions of these traders.

How to find a stock to short squeeze?

There are some certain rules that you should follow in order to find a stock that is likely to experience a short squeeze. Despite the data for short selling not being accurate, nor up to date, there are a couple of ways in which you can use data. These include:

  • Short interest float / percentage – This allows you to spot short squeezes. The float represents the total percentage of any given company’s stock that is traded on the market. A short interest percentage of greater than 20 is considered by many traders as high.
  • Time to cover ratio – This is worked out by taking the total number of short positions on a certain stock and dividing it by the daily average volume of that stock. This signifies how bullish or bearish traders are on the chosen stock. Ideally you want a stock that has a double figure cover ratio.
Also read: How to compare energy tariffs online

How to make money from a short squeeze position?

A short squeeze works by taking a long position on a stock when traders are short selling in order to close their position. For example, if a company that was trading at $10 per share all of a sudden announced that it could lose many of its assets; many traders would begin shorting the stock is its value decreases to $2 per share.

After an internal review, it turns out that the company will not lose any of its assets and so the price of the stock begins to go up because of this news. Short sellers begin to close their positions in order to minimize their losses. By buying these shares, going long, you could profit because short sellers will be anxious to get rid of the stock and thus more likely to accept lower prizes.

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Guest Author- John Bickley

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