Short Squeeze Explained

Views 46KMay 17, 2024

You might have heard about the story of GameStop if you started investing in stocks before 2021.

In January 2021, GameStop (GME), a retailer in America, was heavily shorted by many hedge funds. Yet shortly after, users on the Wallstreetbets, a Reddit message board, urged retail investors to buy in GME, pushing its share price up against aggressive short-sellers.

The frenzy climaxed when numerous celebrities, notably Elon Musk, appeared to express their support for the movement on Twitter.

Apart from GME, other heavily-shorted stocks, including Theatres (AMC) and Blackberry (BB), also saw their share prices surging. On January 28, 2021, GME's share price spiked to a peak of over $483, roughly 190 times the lowest price of $2.57 on April 3, 2020. This caused hedge funds to lose billions of dollars.

So this movement was dubbed an "epic short squeeze" by the media.

We've already known short-sellers can often profit from a price decline. But if the share price rises instead of falls as expected, those with short positions would lose money, and may be forced to close their positions.

Short Selling

Short selling means that you expect the price of a stock to fall, then you sell some borrowed shares at a higher price, hoping to buy the same number of shares back at a lower price and return them to lenders.

There are risks associated with short selling like any other investment strategy but when you short it theoretically involves unlimited loss potential since the market price of the stock sold short may continuously increase.

Short Squeeze

When short sellers have to buy back shares to cover their shorts, the demand for the stock could exceed the supply, driving up the price even higher. This situation is known as the "short squeeze".

Past performance does not guarantee future results. Investing involves risk and the potential to lose principal.