# Short Squeeze: What It Is and How to Profit from It

Potential Signals to Predict a Short Squeeze

A short squeeze occurs in financial markets when a sudden surge in asset prices forces bearish investors (short sellers) to buy back shares to cover their positions, driving prices even higher. This scenario, which can result in significant market volatility in a short period, defies market expectations. In this article, we explore what a short squeeze is, how to anticipate it, and strategies to capitalize on it.

# How Does a Short Squeeze Work?

To understand a short squeeze, one must first grasp the concept of short selling. Short selling is an activity where investors borrow assets (stocks or cryptocurrencies) from a broker (or exchange) to sell them, anticipating a price decline. The proceeds from the sale are held as collateral in a margin account. If the price drops, the short seller buys back the stocks at a lower price, pocketing the difference as profit.

However, if the price increases, the short seller incurs losses. To mitigate these losses, the short seller may buy back the assets at a higher price. In the cryptocurrency market, this often involves reducing or closing short positions by buying at elevated prices. This buying activity can cause trading volumes to spike, pushing prices higher and triggering a short squeeze.

The opposite of a short squeeze is a long squeeze, a less common phenomenon where traders with long positions are forced to sell under downward pressure.

# Case Studies: Opportunity for Some, Nightmare for Others

### Volkswagen

One of the most significant short squeezes in financial history occurred during the 2008 financial crisis with Volkswagen AG (VWAGY). At that time, major funds shorted Volkswagen stock, predicting a bleak outlook. The squeeze began when Porsche Automobile Holding SE (POAHY), Volkswagen’s major shareholder, announced it had increased its total stake to roughly 75%. Coupled with the state of Lower Saxony owning over 20%, very few shares were available for trading. Short sellers had no choice but to repurchase shares, driving the stock price from $210 to an all-time high of $1,070 within a few days.

### Tesla

Short sellers often target companies they consider overvalued. For instance, Tesla Inc. (TSLA) attracted many investors with its innovative approach to electric vehicle production and marketing. While many believed in Tesla’s potential, short sellers bet heavily on its failure. By early 2020, Tesla had become the most shorted stock on American exchanges, with over 18% of its shares shorted. From late 2019 to early 2020, Tesla’s stock price soared by 400%, leading to massive losses for short sellers estimated at $8 billion.

### GameStop: From $5 to $120

GameStop Corp. (GME) became a notorious short seller graveyard. Following the pandemic, many analysts and investors predicted that GameStop would go bankrupt as consumer traffic dwindled and stores frequently closed. This made GameStop a favored target for short sellers, with short positions exceeding 100% of its issued shares. As the stock price suddenly surged, short sellers faced massive losses, and the event attracted significant attention in the stock market. Hedge funds were forced to buy back shares to cut losses, pushing the stock from under $5 to over $120 within a month.

# Short Squeezes in the Cryptocurrency Market: Bitcoin and Ethereum

Short squeezes are frequent in the cryptocurrency market, especially for Bitcoin. The Bitcoin derivatives market often employs high leverage, meaning even minor price movements can pressure these positions or lead to liquidations. Notable examples include:

### Bitcoin: From $3,000 to $12,000 in 2019

In early 2019, Bitcoin’s price was trapped within a narrow range after a decline. With market sentiment deteriorating, many investors took short positions, expecting the downturn to continue. At some point, the price swiftly broke out of its range and never re-tested that level, signaling a broad short squeeze.

### February 2021 Bitcoin Short Squeeze

In February 2021, during a bearish sentiment, Bitcoin surged over 20% after Tesla announced it would accept Bitcoin as a payment method. Regardless of the rationale behind the short sellers’ positions, positive news can reverse trends. This announcement led traders who had not bet on Bitcoin to buy at higher prices, fueling the rally.

### Ethereum: Breaking Through $2,000 Resistance

Short positions can also be unwound following the breach of major technical resistance. For Ethereum, a prolonged downtrend was reversed when it broke through the key resistance at $2,000, leading to the clearing of short positions and subsequent price increases.

# Two Potential Signals to Predict a Short Squeeze

Predicting a short squeeze accurately is nearly impossible. However, tracking assets with high short interest can help investors respond quickly when a squeeze occurs. Key indicators used by major traders to foresee short squeeze risks include:
– **Short Interest (미결제약정)**: This ratio represents the number of shares shorted relative to the total circulating shares, indicating the extent of short betting on a particular stock. A short interest ratio between 15% and 30% can signal changing investor sentiment.
– **Days to Cover (미결제약정 비율)**: This metric shows the expected number of days required to unwind short positions based on average daily trading volume. A higher value indicates a greater vulnerability to a short squeeze.

Online resources like MarketBeat provide valuable data on short interest and days to cover, aiding traders in market assessments.

# Monitoring Crypto Long and Short Ratios and Futures Positions

In the cryptocurrency market, one precondition for a short squeeze is that short positions must outnumber long positions. With more short positions, there is greater liquidity to drive prices higher. Thus, the long/short ratio is a valuable tool for traders, offering insights into market sentiment. Various exchanges offer real-time long/short ratios for different coins, and platforms like CoinGlass provide free access to funding rates and diverse futures indicators.

# Betting on a Short Squeeze: Research and Caution Required

Short squeezes frequently occur in markets with high leverage. The risk, however, is that heavy leverage usage by many traders can lead to cascading liquidations and significant price swings. Therefore, it is crucial to fully understand the impact of a squeeze before entering a short or long position. Failing to do so can result in substantial losses.