A short squeeze occurs when a stock or other asset jumps sharply higher, forcing traders who had bet that its price would fall (i.e. short sellers), to buy it in order to forestall even greater losses. Their scramble to buy in order to cover their short position (i.e. return the shares their are “short” to the lender), purchasing large volumes of stock relative to the market volume, raises the price of the shorted stock, thus triggering more short sellers to cover their positions by buying the stock. They are literally squeezed out of their short positions. This dynamic can result in a cascade of stock purchases and an even bigger jump of the share price. Look for sharp upward spikes in a stock’s graph chart to identify a possible short squeeze.
Why Short Squeezes Happen
Short-sellers open positions on stocks that they believe will decline in price. However sound their reasoning may be, it can be upended by a positive news story, a product announcement, or an earnings beat that excites the interest of buyers.
The turnaround in the stock’s fortunes may prove to be temporary. But if it’s not, the short seller can face runaway losses as the expiration date on their positions approaches. They generally opt to sell out immediately even if it means taking a substantial loss. That’s where the short squeeze comes in. Every buying transaction by a short-seller sends the price higher, forcing another short-seller to buy.
The phenomenon of short squeezes most frequently occurs in small-cap markets—more specifically with penny stocks (i.e. stock of companies which trades at very low prices, usually under $1, thus “penny”). This is often due to penny stock’s lack of transparency, regulation and especially a lack of liquidity of free-floating stock.
There is a number of notable short squeezes throughout history, the latest one being the GameStop short squeeze, taking place in early 2021. Here are some other examples:
In October 2008, a short squeeze triggered by an attempted takeover by Porsche temporarily drove the shares of Volkswagen AG on the Xetra DAX from €210.85 to over €1,000 in less than two days, briefly making it the most valuable company in the world. Then-Porsche CEO Wendelin Wiedeking was charged with market manipulation but was acquitted by a Stuttgart, Germany court.
In November 2015, Martin Shkreli orchestrated a short squeeze on failed biotech KaloBios (KBIO) that caused its share price to rise by 10,000% in just five trading days. KBIO had been perceived by short sellers as a “no-brainer near-term zero” due to its only drug in the market just having flopped and the company having insufficient cash to pay over $6 million in debt.
The electrical vehicle company Tesla’s stock frequently has been on the list of most shorted stocks. However, short sellers that bet against the stock lost a massive $40 billion in 2020, triggering several smaller scale short squeezes and making it the single most unprofitable short of the year.
This prompted Elon Musk to mock the failed short attacks on his company by announcing the sale of red satin “short shorts” as a marketing gag on Tesla’s website in July of 2020.