Short selling allows traders lớn profit off an asset’s price decline. It’s a very common way to lớn manage downside risk, hedge existing holdings, or simply express a bearish outlook on the market. 
However, shorting can be an exceptionally high-risk trading strategy at times. Not only because there is no upper limit for the price of an asset, but also due to lớn short squeezes. A short squeeze can be described as a sudden price increase. When it occurs, many short sellers get “trapped” & quickly rush to the exit khổng lồ try & cover their positions.

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Naturally, if you’d like to understand what a short squeeze is, you’ll need khổng lồ understand what shorting is first. If you’re not familiar with shorting and how it works, check out What is Shorting In the Financial Markets?.
In this article, we’ll discuss what a short squeeze is, how you can prepare for it, & even profit off it in a long position.

What is a short squeeze?

A short squeeze happens when the price of an asset sharply increases due to a lot of short sellers being forced out of their positions.

Short sellers are betting that the price of an asset will decline. If the price rises instead, short positions start to lớn amass an unrealized loss. As the price goes up, short sellers may be forced to lớn close their positions. This can occur via stop-loss triggers, liquidations (for margin và futures contracts). It can also happen simply because traders manually close their positions to avoid even greater losses.
So, how do short sellers close their positions? They buy. This is why a short squeeze results in a sharp price spike. As short sellers close their positions, a cascading effect of buy orders adds more fuel to lớn the fire. As such, a short squeeze is typically accompanied by an equivalent spike in trading volume.
Here’s something else lớn consider. The larger the short interest is, the easier it is khổng lồ trap short sellers và force them to close their positions. In other words, the more liquidity there is to trap, the greater the increase in volatility may be thanks khổng lồ a short squeeze. In this sense, a short squeeze is a temporary increase in demand while a decrease in supply.

The opposite of a short squeeze is a long squeeze – though it’s less common. A long squeeze is a similar effect that happens when longs get trapped by cascading selling pressure, leading lớn a sharp downward price spike.

How does a short squeeze happen?

A short squeeze happens when there is a sudden increase in buying pressure. If you’ve read our article about shorting, you know that shorting can be a high-risk strategy. However, what makes a short squeeze a particularly volatile sự kiện is the sudden rush to lớn quickly cover short positions (via buy orders). This includes many stop-loss orders triggering at a significant price level, và many short sellers manually closing their positions at the same time.

A short squeeze can happen in essentially any financial market where a short position can be taken. At the same time, the lack of options to lớn short a market can also lead to large price bubbles. After all, if there’s no good way lớn bet against an asset, it may keep going up for an extended period.

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A prerequisite of a short squeeze can be a majority of short positions over long positions. Naturally, if there are significantly more short positions than long positions, there’s more liquidity available khổng lồ fuel the fire. This is why the long/short ratio can be a useful tool for traders who want to lớn keep an eye on market sentiment. If you’d like to check the real-time long/short ratio for chamichi.com.vn Futures, you can vì chưng it on this page.

Some advanced traders will look for potential short squeeze opportunities to lớn go long & profit off the quick spike in price. This strategy will include accumulating a position before the squeeze happens & using the quick spike to lớn sell at a higher price.

Short squeezes are very common in the stock market. This usually entails low sentiment around a company, a perceived high stock price, và a large number of short positions. If, say, some unexpected positive news comes out, all those short positions are forced to buy, leading khổng lồ an increase in the price of the stock. Even so, a short squeeze is more of a technical pattern rather than a fundamental event.

According to lớn some estimates, Tesla (TSLA) stock had been one of the most shorted stocks in history. Even so, the price has gone through a number of sharp rises, likely trapping a lot of short sellers.

Short squeezes are also quite common in the cryptocurrency markets, most notably in the Bitcoin markets. The Bitcoin derivatives market uses high-leverage positions, & these can be trapped or liquidated with relatively small price moves. As such, short & long squeezes happen frequently in the Bitcoin markets. If you’d like to avoid getting liquidated or trapped in such moves, carefully consider the amount of leverage you’re using. You should also adopt a proper risk management strategy.
Take a look at this Bitcoin price range below from early 2019. The price was contained in a range after a sharp move khổng lồ the downside. Market sentiment was likely quite low, as many investors would be looking for short positions, expecting the continuation of the downtrend.

However, price flew through the range with such haste that the area didn’t even get retested for a long time. It only got a retest years later, during the coronavirus pandemic (also known as “Black Thursday”). This rapid move was quite likely due to lớn extensive short covering.
Summing up, a short squeeze happens when short sellers get trapped và are forced to lớn cover their positions, leading to a sharp price increase. 
Short squeezes can be especially volatile in highly levered markets. When many traders and investors use high leverage, the price moves also tend lớn be sharper, since cascading liquidations can lead khổng lồ a waterfall effect.
Make sure you understand the implications of a short squeeze before you enter a short position. Otherwise, you could kết thúc up with huge losses. If you’d lượt thích to learn more about shorting và many other trading techniques, check out A Complete Guide lớn Cryptocurrency Trading for Beginners.

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Do you still have questions about how khổng lồ short Bitcoin và cryptocurrencies? check out our Q&A platform, Ask chamichi.com.vn, where the chamichi.com.vn community will answer your questions.
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