A short squeeze occurs when the price of a heavily shorted stock rises suddenly and unexpectedly. Short sellers who have speculated on a price drop are forced to buy back their shares to avoid losses, further increasing demand and driving the price higher.
To understand the process, it is important to know what a "short" or short sale is. Investors who short sell stocks borrow shares from a broker and sell them on the market, expecting the price to fall. They hope to buy the shares back later at a lower price in order to return them to the broker and keep the difference as profit. However, when the price of the stock rises, the short sellers' losses also increase.
A short squeeze is often caused by unexpected news, strong quarterly results or other positive developments that cause the share price to suddenly rise. Short sellers come under pressure to liquidate their positions in order to minimise losses. However, as many investors close their positions at the same time, buying pressure increases, which drives the price up even further.
A well-known example of a short squeeze occurred in 2021 with the shares of video game retailer GameStop. The stock was heavily shorted and when retail investors started to buy massively, the price exploded. As a result, short sellers were forced to buy back the stock, which accelerated the price increase. The result was a price increase of hundreds of per cent in just a few days.
Short squeezes are difficult to predict and can lead to extreme market fluctuations, making them a risky phenomenon for all market participants.
