Trading Education

Basic Information on Short Squeeze

We would like to talk about a vicious circle called a “short squeeze” that can happen with traders on the market. In order not to be trapped, a market participant must understand how short positions work, see potential short squeezes, and act quickly. In today's article, we'll cover everything one needs to know about short squeeze, including its causes, definitions, and trading recommendations. In turn, experienced traders know how to profit from a short squeeze.

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What is a short squeeze?

A short squeeze happens when prices rise too quickly due to a lot of short-sellers being forced out of their positions. This process is at odds with the expectations of analysts and market participants. Short squeezes can hit especially hard on leveraged investors because they can spend more money to buyback. During the short squeeze, markets behave in unexpected ways and volatility increases dramatically. It is caused by a quick and unexpected jump in the price of an asset. Sellers will seek to abandon their short positions as prices rise. There is a shift in the dynamics of supply and demand, which leads to further price increases and exacerbates the effect of the short squeeze.

The “short squeeze” method of market manipulation is often used by large investors. They buy back the oversold crypto asset, stimulating a strong increase in its value. This is usually followed by a decline in the market price to its previous values. Deliberately creating such situations on ordinary stock exchanges leads to criminal liability, but not in the cryptocurrency industry. As cryptocurrency trading has developed, there has been an increase in the number of traders taking short positions in the bear market. The increase in such deals poses a threat of “short squeeze”.

How to identify?

Short squeeze identification is done by many traders through indicators to find oversold assets. If a stock or other asset is oversold, its price can be expected to increase. Popular indicators that are used to identify oversold areas include the Relative Strength Index (RSI) and the Momentum Indicator.

The lower percentage of short positions means that few people are currently trading assets. This means that they can expect the price to rise.

To see the percentage, divide the number of assets sold by the total number of assets in the supply, and then multiply the result by 100.

Short squeezes tend to catch markets off guard, and oversold indicators and high or low-interest rates do not guarantee that a short squeeze will occur. Often, higher-than-expected company revenues, technological breakthroughs, or new products shifting the sector lead to unexpected price increases.

How to trade?

We will encounter many more short squeezes as the cryptocurrency market is highly volatile. At such moments, professional investors recommend waiting for the recovery of healthy buying trends, when the manual pump subsides, the market value of the asset is corrected, and trades in the bull market resume.

Inexperienced short-term traders are at a loss because of the short squeeze, as it is difficult to predict. A high rate of short positions does not mean that further growth or depreciation will follow. It is worth paying attention to a serious increase in volume on the chart, periods of strong bullish movement, closing short positions, and the appearance of fakes to drive bears into traps.

One should pay attention to the following recommendation:
  • Apply intraday and short-term strategies;
  • Prepare a list of assets to enter the market at the moment of panic, use squeezing out as a way to enter a trend;
  • Always follow the rules of risk management;
  • Make decisions based on live charts, such as TradingView.
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