Large players can easily manipulate an asset with limited market capitalization, causing a cascade effect to drive the price in either direction. However, in cases where the market doesn’t follow the trader’s prediction, and the asset instead rises in value, traders will rebuy in a frenzy to minimize their losses. In most cases, especially with cryptocurrencies, it’s much easier to short an asset using a derivative contract, and since some have an expiration date, traders are forced to act quickly. Short selling is standard practice and keeps both investors and companies on their toes. GameStop was recently reported as the most shorted company on the S&P 500, primarily due to the public sentiment that it wouldn’t survive the shift away from retail stores during the coronavirus. Enough investors started buying the stock late in 2020 and the share price began to rise noticeably late in 2020.

Aggressively growing stocks are generally more susceptible to long squeezes, especially if the volume is very high. Focusing on investing in value is the best way to handle these squeezes. Undervalued assets will usually recover unless there was a more intrinsic reason for the sell-off. Being caught on the wrong side of a short squeeze can be devastating, and a great way to avoid being stuck in one is to place hard stops on all short positions. This can help protect your capital against sudden market movements in either direction.

A dead giveaway of a short squeeze if there are more short positions than long positions on the market. Not everyone is familiar with how trading works, so in today’s article, we’re going to explore trading strategies like short selling or shorting and discuss the crypto short squeeze phenomenon. Financial markets are in a constant state of buying and selling, in which supply and demand is established. However, many other intricate factors can influence price action in the short term and long term.

By avoiding high leverage, you can limit the likelihood of your short position being pushed over its liquidation threshold, protecting your solvency until the short squeeze inevitably fails. As you might expect, short squeezes are designed to be profitable. A short squeeze can result in extraordinary profits for those that participate early, and doubly so for those that instigate one. For some, short squeezes can represent incredible opportunities for profit.

1. Unfortunately, instead of the price falling, it increases to $12,000.
2. Let’s learn how to spot the next crypto unicorn worth your investment.
3. This can occur via stop-loss triggers, liquidations (for margin and futures contracts).
4. There is considerable skepticism among investors about whether this drug will actually work.
5. For example, traders can also look for oversold conditions which could create an environment ripe for a short squeeze.

But an extremely high reading could be a sign of a coming short squeeze, which could force the price higher. When identifying stocks at risk of a short squeeze, two useful measures are short interest and the short interest ratio. Short squeezes are high-risk/high-reward moves that typically get increasingly risky and less potentially profitable the longer they go on. Financial market technical analysis employs tools such as chart patterns, indicators, and trendlines to determine the best buying and selling…

However, what makes a short squeeze a particularly volatile event is the sudden rush to quickly cover short positions (via buy orders). This includes many stop-loss orders triggering https://www.currency-trading.org/ at a significant price level, and many short sellers manually closing their positions at the same time. A short squeeze can seemingly happen suddenly with price rising parabolically.

Crypto Short Squeezes: How They Work and Avoidance Strategies

For most investors, it is unwise to participate in a short squeeze. But for those with a thorough understanding of how they work, including the conditions that lead to them, they can be incredibly profitable opportunities. Treasury think the mandatory government debt ceiling is going to be reached in days and it has laid in lots of funky mechanisms to stop the U.S. defaulting. Those money stashes, which are huge, may last until June before the government is out of money to pay the bills.

As short sellers close their positions, a cascading effect of buy orders adds more fuel to the fire. As such, a short squeeze is typically accompanied by an equivalent spike in trading volume. Since the cryptocurrency markets have borrowed a lot of concepts from traditional finance and the stock market, you shouldn’t be surprised to come across terms like short selling or short squeezes. Short interest is the percentage of total short positions when dividing the number of shorts versus the number of cryptocurrencies in circulation. Heavy short interest implies a crowded trade and a potential setup for a short squeeze. The next massive short squeeze happened on April 2, 2019, when Bitcoin price broke upward out of its downtrend resistance for a 22% move in just one day.

Short squeeze examples

A short squeeze is still more of a technical pattern than a fundamental occurrence, though. Here, traders borrow funds from an exchange, open a short position, and pay exchanges after exiting their positions. However, this varies between exchanges since some charge a commission for every four hours the position is open. Most cryptocurrency exchanges that allow margin trading have features such as stop-loss, minimizing the loss incurred by short-sellers. Online resources like MarketBeat provide useful short-selling data such as the largest short interest positions, changes in such positions over time, and short interest ratio. Exchanges such as the New York Stock Exchange and the Nasdaq also publish short interest data for the exchanges as a whole.

However, several other important metrics can be measured and analyzed which can tip traders off that a short squeeze is possible. A heavily dominant short-side of the market, combined with soaring open interest, and prices at potential lows are all factors in any short squeeze setup. Because a short https://www.investorynews.com/ position closing results in a buy order, a large influx of short positions closing at once can push prices of the underlying asset up. When there is heavy short interest in the market, oftentimes a contrarian move will force short-sellers out of their positions, causing a short-covering rally.

What Is A Short Squeeze?

It’s also imperative to understand that the crypto market is extremely volatile, and shorting is a high-risk strategy. Imagine a crypto exchange that has sold its depositors’ crypto into stablecoin, a big short. Then they might frantically try and cover that short and appear to hold the depositors’ crypto in the crypto the customers thought they had. Although short interest is the more important factor, how high open interest is as a whole matters. If open interest is low, there may not be enough short positions for a meaningful short squeeze. Short squeezes occur most frequently when open interest is rising, suggesting that more market participants are entering positions in anticipation of a breakout.

It only got a retest years later, during the coronavirus pandemic (also known as “Black Thursday”). If you want to avoid becoming liquidated or trapped in such moves, https://www.topforexnews.org/ carefully assess the amount of leverage you’re utilizing. Generally speaking, short squeezes are brief events that last only a few hours or days at most.

How To Discover Crypto Unicorns Early On

The primary indicators investors and traders can watch for include short interest, short interest ratio, open interest, funding rates, and much more. Plenty of technical indicators can also help support the setup of a potential short squeeze. For example, traders can also look for oversold conditions which could create an environment ripe for a short squeeze. Perhaps the most famous short squeeze in recent times was the GameStop GME situation in January 2021. GME shares climbed by more than 2,000% in a single month and made a spectacle of markets. Large businesses like energy producers regularly hedge against falling energy prices in this way.

Against this backdrop, short sellers were forced to buy back the shares they sold, which helped drive Volkswagen’s share price up to €999. Short sellers are betting that the price of an asset will decline. If the price rises instead, short positions start to amass an unrealized loss.

Regardless of how sure an investor is about an asset’s potential to depreciate, a short position can quickly be wiped out by something as simple as a product announcement or an upbeat news story. While these shifts may be temporary, it can lead to severe losses and even complete liquidation if left unchecked. But if it’s not, short sellers 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.

How does a short squeeze happen?

During the 2008 financial crisis, Porsche Automobile Holding SE (POAHY), already a major holder of Volkswagen AG (VWAGY) shares, increased its total stake in Volkswagen to about 75%. The state of Lower Saxony also owned more than 20% of the company, leaving few remaining shares available to trade at a time when the stock was being heavily shorted. Hedge funds and other short sellers were suddenly left in a tricky position as Porsche’s move meant that not all of them could cover their positions.