INVESTING EXPLAINED: What you need to know about a short squeeze – when short sellers scramble to cover their positions to limit their losses
In this series, we break down the jargon and explain a popular investment term or theme. Here’s the short squeeze.
What is this?
We’re talking about a stock market phenomenon, not a short-lived romantic relationship.
When investors believe the price of a stock will fall, they will sell that stock in a process called shorting.
These speculators borrow part of the shares from a third party – who receives a fee – in the hope of buying back the shares at a lower price and making a profit. However, the best plans may fail as the stock may rise rather than fall.
The price can rise sharply as short sellers scramble to cover their positions and try to limit their losses.
Pressure: The best-laid plans may fail as stocks may rise rather than fall
Then why would the price go up?
There are a number of reasons. The short sellers may believe that the company in question is about to deliver earnings that are worse than forecast, or reveal that current trading is disappointing.
But the results can be unexpectedly good. Even if the news is bad, it can have a negligible effect on the share price.
There are also contrarian investors who monitor which stocks are shorted and buy them hoping to profit from a short squeeze.
Are UK stocks going short?
Yes that are they. The list includes Asos, Barratt Developments, Currys – and Ocado.
However, Ocado is currently in the middle of a short squeeze in the wake of rumors of a bid from Amazon.
Famous short squeezes?
A lot of. In 1923, Clarence Saunders, founder of the Piggly Wiggly supermarket chain, tried to thwart short sellers by borrowing from banks to buy the company’s stock.
But Saunders was eventually forced into bankruptcy.
In 2008, short sellers targeted Volkswagen, calculating that a rumored deal with Porsche would not materialize.
When Porsche revealed it had built up a stake in Volkwagen, the automaker’s shares jumped from €211 to €1,000 in two days, briefly making it the world’s most valuable company. The GameStop saga is the most celebrated example – to date – of recent times.
Why is that?
Eat The Rich: The GameStop Saga, a Netflix series, tells the story of how amateur traders on platforms like Reddit took on Wall Street pros in 2021 by buying stock in this low-rated video game store. Lockdown boredom drove much of the buying.
GameStop shares rose 1,500 percent in a short squeeze, raising fears that the entire financial system was in jeopardy. Tesla boss Elon Musk got involved and became an anti-capitalist hero in the eyes of some.
Why is Tesla in a short squeeze?
Shares of Tesla are up 135 percent this year, to the chagrin of short sellers who thought the rally would be short-lived, but are now facing big losses.
There is some optimism that the Tesla price could return to $314, its 2022 high, amid renewed confidence in the electric vehicle maker’s prospects.
The mood may change if Musk continues his cage fight against meta boss Mark Zuckerberg, but who knows?