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  • Writer's pictureCurtis Thompson

Short Squeeze

With the recent drama around stocks such as GameStop ($GME) and AMC Entertainment Holdings ($AMC), the term “short squeeze” became a huge talking point on some parts of the internet. Retail investors were hoping for a short squeeze, and even those who did not have much investment experience were joining in.

In this article, we will look at shorting stocks and the concept of a short squeeze.

What Is Stock Shorting?

At the most basic level, investors will buy shares when they believe the price will go up, and then sell those shares for a profit. These share prices increase when the companies behind the stocks are doing well, and so investors will essentially be betting that a stock will do well.

Stock shorting is a method to bet that a stock will actually perform poorly and that the price will go down.

Short sellers will borrow shares of an asset and sell it. They will then hope that the value of the share falls so that they can rebuy the shares that they sold at a lower price. If this happens, they can return the shares to the original owner, and keep the profit that they made.

For example, a short-seller might borrow and sell a single GME stock at $300. If the price of GME then drops to $100, they can rebuy the share and give it back to the original owner. In this example, the short seller has actually made a $200 profit.

What Happens If The Share Price Goes Up?

Short sales have an expiration date, and so they need to return the shares before a certain point. If they do not return the share, then they must pay interest on the shares until they do. This can become quite costly, so short-sellers generally do not want to hold onto their shorts for too long after the expiration date.

Short sellers also don’t want to have to buy back the shares at a higher price than they sold them for. So, if the share price is high, they must choose between selling for a high price and making a loss or holding on and hoping the share price goes down while they pay the interest.

A Short Squeeze?

A short squeeze can occur when short sellers decide that they would rather rebuy the stock at a high price to cut their losses. If lots of shares have to be bought to fulfill these shorts, the high demand for shares could cause the share price to rapidly increase.

This rapid increase in share price due to shorts being fulfilled is called a short squeeze.

Short squeezes are often triggered by positive news about a company, that excites the interest of buyers. This positive news causes the share price to increase, and short-sellers may believe that the share price is only going to increase. They buy stocks to end their short, pushing the price up further and causing another short seller to buy stock. It becomes a domino effect, and the price increases rapidly.

Famous Short Squeezes

During the 2008 global financial crisis, a short squeeze caused the price of Volkswagen AG shares to increase from around 200 euros to over 1000 euros per share. This increase made Volkswagen briefly the most valuable company in the world. The positive news that triggered this short squeeze was a potential takeover by another car manufacturer Porsche.

In January 2021, a short squeeze was triggered on GameStop after some major investors bought into GameStop. This was compounded by a short interest in the company of over 100%, meaning that more than 100% of the shares had been sold by short-sellers – something which rarely happens as shorted shares have to be re-lent. This short squeeze saw the value of GameStop grow around 30 times greater than it was at the start of the month, after retail investors from the social media platform Reddit drummed up interest in the stock.

When broken down, a short squeeze is actually a very simple concept. Short-sellers borrow shares and then sell them, hoping to rebuy them at a lower price and take home the profit. If the price increases instead, short-sellers may rush to buy back in and cut their losses. This can cause the price to rapidly increase, as seen in examples such as the 2008 Volkswagen short squeeze or the 2021 GameStop short squeeze.

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