A short squeeze is usually associated with investors playing on a market that they do not like much. These types of investors are known as short sellers. Big profits can be made with this sort of investing, especially if they are successful in taking advantage of a short squeeze.
This process acts against most usual rules of trading and sees and investors sell the stock and then wait to buy it back if / and when its price falls. In order to fully understand how these types of investors operate and how profits are made keep on reading. The topic Short Squeeze: In-Depth Guide On How to Profit from one is indeed very important to learn.
How does short selling work?
Short selling and making money off the back of a short squeeze is something that typically gains negative opinion amongst many investors and financial experts. But is should be noted that some of the best investors out there are short selling stocks to make large profits.
What these investors do is build their entire strategy around making money when the price of a certain stock goes down rather than goes up. The process works with the investor believing the price of the stock will go down, due to it being overvalued, and so they lend stock via a margin account from a brokerage firm. The investor then sells the stock and keeps the money from the sale. The investor now has a short position. If / when the price goes down, the investor then buys the stock back at the then lower price and gives them back to the brokerage firm that lent them the stock in the first place. In this situation the investor benefits from the difference in the price they initially sold the stock for and the price the stock was bought back for.
However, it can all go wrong for an investor if the price of the stock goes up rather than down as they anticipated. As a result of the stock price going up, the investor has to pay more money to buy the stock back than what was raised from the initial sale of the stocks. To avoid significant losses the investor must sell the stock quickly in case the price of the stock continues to go up any further.
In these situations, those investors going long benefit greatly. This is because short sellers begin to buy back their stocks, which has the effect of increasing the price of the stock further. This increase causes even more short selling investors to buy back. If enough do it, this can cause a rally and investors begin to panic buy. This is what leads to a short squeeze occurring. For those investors who have held onto the stock throughout all of this volatility, they see big profits.
This only happens when investors selling short cause a price increase on a stock that is widely shared. In order to get rid of their short positions, investors buy back, thus creating large demand. A squeezing then occurs as they each aim to get out of their short position as fast as they possibly can, thus leading to a further increase in price. As more and more investors try to limit their amount of losses, by buying back, the squeeze becomes even greater.
Making money from a short squeeze
There is usually always a catalyst, or some kind of event, that results in the price of the stock going up against investors who are short and thus creates the short squeeze. Catalysts include things such as announcements being made by the company or a certain economic or political occurrence. In order to make money from a short squeeze, they must first be predicted. It is useful to use specialist trading software to help with identifying the trends and data that can predict the occurrence of short squeeze. Some of these indicators including:
- The news – Keeping abreast of the latest political, economic and business news headlines allows an investor to stay ahead of the rest of the market. Doing so will allow an investor to see if any of the companies that they invest in or performing good or bad and what their plans for the future are.
- Short interest ratio – This is calculated by dividing the daily average trading volume by the short interest. This can be worked out for any stocks that may be of interest to an investor. The greater the ratio, the greater the probability that short sellers will force the price of the stock up.
- Short interest percentage – This is calculated by dividing the total amount of stocks that are short by the total amount of any stocks that are outstanding. The more investors that are short, the more likely it is that the price will bounce, and a short squeeze occurs.
- Daily moving average – With this useful tool an investor can see how the price of a certain stock has performed over any given date period.
Making a move on a short squeeze
Once calculations have been made, trends assessed, and news stories researched an investor is in a position to make a move, at the right time of course. Investors should look out for a short interest ratio that is five or below. This signifies that short sellers are likely to panic and so it is the ideal time for an investor to move in on the likelihood of a potential short squeeze occurring.
What to remember when it comes to a short squeeze
Like anything within a volatile market, it is not easy to perfectly time a spike against short sellers. For those investors looking to make a profit from a short squeeze, they have to dedicate lots of effort and time on working with indicators and charts, exploiting trading accounts, researching the markets and any trends, looking into the history of companies’, plus much more.
However, if you do successful accomplish all of these things an investor can profit for a short squeeze very lucratively and very quickly.