A complete guide to short squeezes in trading

A short squeeze is when traders who have ‘shorted’ a stock​ (for example, bet against it) see its price suddenly rise, forcing them to try to exit their positions as quickly as possible before they incur further losses. This flurry of activity — and sometimes panic — surges demand for the stock, sending its price ever higher. A stock experiencing a short squeeze will usually surge and then plummet in value extremely quickly.

Short squeezes can also occur in other financial markets, such as cryptocurrencies, but are usually referenced in terms of the stock market.

A short squeeze occurs when there is a sharp and unexpected change in price of a financial asset, usually caused by positive news release on a stock’s performance, an unexpectedly favourable earnings report or a macroeconomic factor that suddenly leads to higher demand, creating a localised stock market bubble​.

This may make short sellers want to abandon their bear market positions, but in turn, this only increases the demand for stocks to rise and supply to reduce. The pressure to rebuy the stock and close their positions can be damaging to their trading portfolio, however, as they will spend a far higher figure than the original value of the position in an attempt to close them.

Because a short squeeze happens so quickly, even the most experienced traders are often caught off guard. However, once you understand what causes one, there are indicators that can help you to predict a short squeeze, including the following.

Attempts to short squeeze a stock are nothing new. But there are few more ill-advised and ultimately calamitous short squeeze examples as that of one Clarence Saunders, who took on Wall Street to try to beef up stock in his grocery business — and lost.

Saunders’ retail chain Piggly Wiggly revolutionised shopping, introducing the world’s first ever self-service supermarkets, which proved such a hit that by 1922, he had sold 1,200 franchises across the US, earning the business a listing on the New York Stock Exchange. But when a number of those franchises folded, traders began to short Piggly Wiggly’s stock.

Saunders was incensed and decided to teach Wall Street a lesson. He borrowed $10m (about £150m today) to buy as many shares as possible to force the price up and ruin the short sellers. By March 1923, he had snapped up 99% and cunningly got his brokers to loan 42,000 of them to short sellers. Piggly Wiggly’s stock value duly trebled, and then he played what he saw as his trump card — recalling all the company’s shares from those short sellers.

Unfortunately for him, Wall Street realised that the only way for almost all short sellers to exit would be to buy from Saunders, who could name his price, so the NYSE launched an investigation. It ultimately suspended trading of Piggly Wiggly, saying such a “concentration of holdings” prevented free trade of the stock. Saunders was forced to do deals with the short sellers, which made him money — but nowhere near enough to cover his $10m outlay.

Just four months after the stock’s peak, he’d quit his role at Piggly Wiggly and within a year, he filed for bankruptcy.

When Porsche announced in 2006 that it wanted to boost its shares in Volkswagen to 31%, the German car maker’s stock started to rise. But VW was in serious debt and over the next year, many institutional traders/hedge funds believed the stock was overvalued and took short positions.

As the financial crisis hit and car manufacturing plummeted, many more joined them, confidently expecting VW’s price to crash — especially after Porsche strongly denied market rumours in early 2008 that it would be increasing its holding to 75%. But fast forward to October 2008, and Porsche revealed to a shocked market that it held 42% of VW shares and had options on a further 31%. As another company, Lower Saxony, held a further 20%, this suddenly meant less than 6% of VW voting stock was on the market.

Suddenly there weren’t enough shares available, short sellers panicked as they had to pay to close out their positions, and the resulting supply-demand imbalance led to a monumental short squeeze. VW’s price went from €210 to €1,000 per share in two days, a jump so high that it briefly overtook Exxon as the company with the world’s largest market capitalisation.

The following day, Porsche eased the pressure by releasing 5% of VW shares. Within three days, the stock had dropped 58% and by mid-November, it was down 70% from its peak. Scant consolation, though, for the traders who had lost thousands in the short squeeze.

Elon Musk has always been able to make the headlines — even a tweet will bounce Tesla’s share price up and down — but in August 2020 the company’s stock price, for no clear single reason, suddenly shot up 50%.

The stock had been gathering momentum, but even though there were a few reasons for this – Tesla was about to join the S&P 500 and had just announced a stock split – analysts were baffled by such a sudden, dramatic spike. The most realistic and probable cause is simply the work of short sellers.

That month, Tesla became the most shorted stock​ in the world, with Wall Street sentiment claiming the stock was overvalued and heading for a crash. But a run of good headlines and Musk’s innate talent for PR kept the upward momentum going — so much so that over 2020 as a whole, Tesla stock gained 743%. Not so much of a short squeeze as a slightly longer one — there was no panic, but that left the short sellers who doggedly and ill-advisedly hung on losing a total $40bn.

The world’s largest cinema chain was in danger of rolling its final credits as the pandemic took hold, until a short squeeze and a smart reaction by its CEO changed its fortunes.

The lockdown closure of AMC’s 10,500 screens across the globe left the company facing bankruptcy, resulting in a flood of short selling. But in mid-2021, it had raised $500m by issuing common stock and restructuring its debt, ending the immediate threat of insolvency. As a result, a group of Reddit-based short sellers began buying back the stock and two days later, its price rocketed 300% to $20 a share.

But that was only the beginning. While the first short squeeze faded away, the new retail traders amassed enough shares to become the company’s major stakeholders, raising the price sufficiently for CEO Adam Aron to sell 4.3 million more shares at $10 each. That boosted the price further to $25 but the following day the retail traders, who called themselves ‘the ape army’, piled in again. Within a few hours the stock nearly trebled to $70 and 20 times its value the previous January.

It was then that Aron made his smart move. He realised his company’s future was based on retail traders rather than institutional traders and switched his communications strategy to appeal to them using social media and YouTube. He gave away free popcorn, launched a programme called AMC Investor Connect to change shareholders into customers. Although the squeeze inevitably loosened, the price fell only to around $40 — still eight times its value at the start of the year, giving the company sufficient breathing space to consolidate as cinemas began to reopen. This example is not just of a short squeeze benefiting traders, but one that actually saved a company.

In January 2021, US video game and electronics retailer GameStop seemed in terminal decline. The pandemic had hit the company hard, and traders were so confident it was heading for the wall that at one point a mammoth 140% of its shares were shorted.

But then entered a group of retail traders who teamed up on a Reddit channel called WallStreetBets. They decided to try to force a short squeeze and started buying shares to increase GME’s value. The online buzz they created turned GME into the world’s first “meme stock” and were so successful that short sellers scrambled to cover their positions and buy back the stock at a significantly higher value — almost 200 times the original amount.

For three consecutive days at the end of January, the GME short squeeze accelerated, and its share price doubled. The stock, which was worth less than $4 five months earlier, had hit a pre-market value of over $500. Some major brokers then halted the buying of GME stock, claiming they could not provide the necessary collateral, and within days the price began to tumble to $40. Yet that wasn’t the end of the story. A backlash against the brokers followed and over the next few weeks the price jumped back up to $350 before then losing and regaining 50% of its value in 24 hours.

Trading on a short squeeze can bring an extremely high level of risk. If short selling traders are not able to offload their shares, there is no guarantee of how high a share price will rise after a fundamental event. Therefore, traders may be forced to buy more stocks at double the original value or even higher.

When trading with leverage, this magnifies the extent of losses. These risks should always be taken into consideration when spread betting or trading CFDs on the share market. Consult our money and risk-management guide​ for more information on using controls such as stop-loss and take-profit orders, which can help to protect your capital in losing positions.

However, the risks also come with benefits. For traders with long positions on a stock, a short squeeze can be an advantageous time to take profits. As the price of a stock jumps, and short sellers exit their positions while buying shares to recover losses, a trader could look to capitalise on these movements.

Once the short squeeze has begun, you can trade on it through our derivative products such as spread bets and CFDs on our Next-Generation trading platform. With derivatives, you do not actually own the underlying share, but rather speculate on its price movements. With traditional share trading, you are required to purchase and take ownership of the stock, whereas leveraged products give traders the advantage of placing a small deposit of the full value and receiving full exposure to the market. Remember that margin trading comes at a high risk and losses can surpass profits just as quickly.

At CMC Markets, we also have the educational tools and market insights to support your trades. Whether you’re using our website, our app or our other platforms, we will guide you through the features and tools available. We can give you access to market news and charts and help you place different order types, and we also offer a live help chat service. Our CMC dealers work with you to put into action your decisions and complete the trades you want to make.

Worried about the risks a short squeeze may bring to your share positions? Sign up for a risk-free demo account to practise with £10,000 worth of virtual funds first.