A short squeeze is a market phenomenon in which a shorted security, such as a stock, jumps unexpectedly in price.
Investors who short a stock are betting the stock will go down in value. To capitalize on that, they borrow shares from a broker, then sell them at the current price. When the stock price falls, they buy the shares at the lower price, return them to the broker and pocket the difference.
If the stock price rises instead, a short-seller may lose money — they still have to return the shares to the broker, which may require buying them back at the new higher price.
A short squeeze is an amplified version of that scenario: In a short squeeze, a stock that is heavily shorted by investors suddenly and unexpectedly increases in value. That increase causes short-sellers to attempt to exit their investment, which requires buying the stock. The rush of buy orders from short-sellers boosts demand for the stock, which can push the stock’s price up even higher.
Short-sellers enter the market with a belief that a company and its stock price are overvalued. This approach differs from “going long,” which is when an investor buys stock with the expectation that prices will rise over the long run.
How does a short squeeze happen?
Short-sellers generally are looking for overvalued investments. Companies valued between $100 million and $8 billion (known as small-cap stocks) are good candidates to be shorted, as are stocks with high short interest, or a high percentage of stock shares held by short-sellers. Stock prices on the decline also can attract short-sellers.
The short: First, short-sellers need to have a margin account to execute the trade through their brokerage company. Short-sellers borrow a stock’s shares through a brokerage. The goal is to buy back the stock at a lower price to make a profit.
The short squeeze: Because short-sellers have to buy back and return the borrowed shares, their mass entry into the market can create price competition, causing prices to jump unexpectedly.
This unexpected rise in the share price can signal to other short-sellers to exit the short, further driving the price up. Positive product news or earnings reports can quickly derail a short. Frantic buying can drive stock prices to rise out of control, squeezing the short-sellers out of their positions.
Terms connected to a short squeeze
Short-seller: Investor who tries to profit by betting on falling stock prices.
Short ratio or “days to cover”: The number of days it would take for a company to recover the shorted stocks during normal trading.
Short interest: Percentage of stock shares held by short-sellers.
Margin trade: Borrowing money from your brokerage company to purchase stock.
How to identify a short squeeze before it happens
A short squeeze is part of the risk when you’re a short-seller. To keep track of the likelihood of a short squeeze (and to try to avoid getting caught up in one), explore these three tools:
The Relative Strength Index “measures both the speed and rate of change in price movements within the market,” allowing investors to identify oversold market conditions ripe for a short squeeze.
Nasdaq publishes a semimonthly Short Interest Report, which includes “a summary of the consolidated market short interest positions in all Nasdaq-listed securities.”
Stock screeners such as most shorted stocks from companies like Yahoo Finance can help you identify heavily shorted stocks, too.
GameStop, AMC and other famous short squeezes
You may recognize a few short squeezes from recent history. In the 2000s, a group of investors believed the housing bubble would burst and shorted the market, as depicted in the book “The Big Short: Inside the Doomsday Machine” by Michael Lewis and its film adaptation.
When Porsche announced a takeover of Volkswagen in October 2008, short-sellers scrambled and prices soared. Volkswagen briefly became the most valuable company in the world before prices declined.
Meme stocks, or stocks with viral internet cultural support, have been targets of ongoing short squeezes, starting with GameStop Corp. in 2021. Movie theater company AMC Entertainment Holdings Inc. and brick-and-mortar retailers like Express and Bed Bath & Beyond have been recent short-squeeze targets since 2021.