Short Squeeze and Long Squeeze Explained

/Short Squeeze and Long Squeeze Explained

Short Squeeze and Long Squeeze Explained 2018-05-15T08:15:10+00:00

Short Squeeze & Long Squeeze Guide

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  1. What is a market Squeeze?
  2. What Is A Short Squeeze?
  3. What Is A Long Squeeze?
  4. The Difference Between A Short And A Long Squeeze
  5. How To Take Advantage Of A Market Squeeze?

The financial market is made of literals ups and downs. When it comes to the financial market, nothing is ever assured or guaranteed. A trader is left to predict likely directions of his or her chosen investment contracts through the use of various methods that have been tried and tested over time by the trader or the use of signals and ideas sent out by far experienced traders.

Either of these two methods does not in any way assure a successful outcome for the very trade being made by such traders. The best systems and signal alerts are usually the ones that tend to win trades more than they lose, as there is no perfect system that can assure a 100% win rate on every single trade taken. You can buy or sell a financial instrument just for it to turn around and go in the opposite direction. This brings us to the topic of a market squeeze.

What is a market Squeeze?

Every financial instrument is prone to experience a market squeeze, with or without previous predictions from authorities on the subject matter.

A market Squeeze is mostly accompanied by large trade volumes and surprised spike in the price actions of such financial instrument. Market squeeze is a situation whereby a trader has to close opened trade that has moved against the original and intended position in order to salvage what’s left of the account balance. This condition usually leads to many traders who took trade in the first direction to open new positions in the new directions, thereby further driving the price in the new directions. This will lead to what is known as a market Squeeze action. This resulting surge in price directions will further attract new traders to place a trade in the trending direction of price thereby fueling the trade momentum and adding to the trading volume.

There have been many examples of market squeeze across different financial markets types ranging from currency, stocks, futures, and cryptocurrency. A good example of market squeeze operation is the case of Volkswagen being the world most valuable company on 28 Oct 2008, based on the stock price. Another notable market squeeze is the first and second Harlem Corner that took place in the year 1863–64. This squeeze involved a group of stock spectators and an industrialist by the name Cornelius Vanderbilt. Bitcoin also experienced a market squeeze on April 12, 2018. The cryptocurrency recorded the largest trading volume ever experience, which occurred within one hour. This sent the price into an uptrend, with about 13% gain, even though all indicators were pointing that BTC is in a downtrend. A similar market squeeze event also took place when Bitcoin was at the $19000 –20000 range; the market made a continuous down dip for up to 3 months before showing any sign of an uptrend.

What Is A Short Squeeze?

A short squeeze is a quick or swift rise in the price of a financial instrument that emanates from the absence of supply and a surplus of demand for the instrument. This leaves a great number of short sellers with no choice but to close their positions which in effect pushes the prices even higher. For a short squeeze to occur, a short sale needs to be made.

A short sale occurs when a short seller (an individual or an organization) is involved in the sale of an asset or a financial instrument that the short seller does not own. How does this happen? The seller borrows the asset, usually from a brokerage firm, and sells them as quickly as possible at the same market price. If the share price falls which is typically the short seller’s goal, the short seller buys back the share at a lower price and returns the share initially borrowed. This phenomenon is called “covering,” the short seller makes a profit by selling the shares at a higher price and buys them back at a lower price as opposed to a conventional market merchant that buys a commodity at a lower price hoping to sell at a higher price to make profits. Example of institutions that lend shares for short selling includes J.P Morgan Chase and Co. and Meryll Lynch Wealth Management. The short seller though does not borrow the assets directly from the stock lender but uses a selling broker to arrange for borrowing the stock from a stock lender. In certain instances, the selling broker might also be the stock lender. The short seller makes available some sort of collateral should in case the short seller cannot return the assets borrowed from the stock lender.

How then does a short squeeze occur? A short squeeze would occur if after a short sale, the short sellers’ prediction of the stock price going low backfires and instead the stock price rises. When the stock price starts to rise, many short sellers decide to cut their losses and buy the stocks back before the price goes further up. This influx of buy orders causes the price of the stock to go further up squeezing the short sellers out of their positions thus the term “short squeeze.”

Volkswagen in October 2008 is a classic short squeeze example that caused Volkswagen to be the largest cap company in the world for a short period of time.

A short squeeze could generally be referred to as the risk associated with a short sale. As there is no limit to the rise and fall of shares or cryptocurrency, there is theoretically no limit to the possible loss of a short seller. The profit from a drop in the price of a share is the main advantage of a short sale.

How Does A Short Squeeze Work?

To understand the concept of short squeezing, here is a practical example:

A trading institution or a top investment manager predicted that the price of a cryptocurrency is going to drop from $50 in a week for reasons best known to them. Since this people tend to be correct most of the time with their price action predictions, you and a large number of other traders want to make profits off this prediction. You go ahead and place a sell order on this particular cryptocurrency. After waiting a few days and the prediction turns out to be wrong, the price had risen from $50 to $70 and is likely to go further up, you decide to cut your losses as do many other short sellers who did the same as you and also placed a buy order for that same cryptocurrency before it goes any higher. This sell and buy action effect, further generated a tremendous buying pressure on the stock and the short sellers rushing to cover their positions only to escalate the price further up.

Short selling is a very common market reaction with cryptocurrencies, the price and fluctuation rate of cryptocurrency is never stable just like the other futures and commodities. In early January, bitcoin was trading in the $15000 – $18000 range but formed a downtrend after a week and settled at around the $9000 mark. Bitcoin shorts were generously rewarded generating a profit of as much as 40% before Bitcoin rebounded ever since.

In 1992, billionaire investor George Soros shorted the British pound by risking $10 billion that the value of the currency would fall. He was right and in a single day made a profit of $1billion

What Is A Long Squeeze?

Virtually everything has an opposite; the short squeeze is no different with its exact opposite being the uncommon long squeeze. So what is a long squeeze?

A long squeeze yields from a situation in which investors holding long positions feel the need to sell into a falling market to cut their losses. This pressure to sell usually incites further decline in Market prices. It usually involves a single stock and holders sell to protect against dramatic losses. Long squeezes usually tend to occur in smaller stocks. Short sellers buy when there is a rapid drop in stock price whereas long holders sell when there is a sudden drop in stock price.

Long squeezes are very uncommon because value buyers will come in once the price drops to a point so low and bid the shares back up. Some events that could cause a long squeeze include a very bad earning report that causes future investors to cast doubts over the future success of a company. An example of a long squeeze was in 2008, the company, Bear Stearns, was wiped out by aftermarket rumors stated that the company had cash concerns. The investors started selling the “scrip” which is the equivalent of legal tender, this affected many other stop order losses and accelerated the decline of the company’s stock.

How Does A Long Squeeze Work?

Since long squeezes are very rare and even hard to tell the difference between a long squeeze and a stock that legitimately needed to be sold due to fundamentals, an investor needs to do the research before trading a long squeeze. Long squeezes usually occur due to events, media news or rumors.

One of the largest markets for cryptocurrencies is China. At the start of the year, China banned all websites that offered cryptocurrency trading services in the country. Additionally, Google banned advertisements of cryptocurrency on its platform. This has led to the fall in the price of certain cryptocurrencies which could lead to certain long holders cutting their losses by selling into the market.

As there are short positions in the short squeeze, there are long positions in the long squeeze. A long position in the financial market means the holder of the position owns a positive amount of the financial instrument as opposed to the negative amount owned by an investor in the short squeeze. Long traders can afford to wait indefinitely through a price fall, unlike short traders who cannot afford the risk of multiplying losses since there are possibilities that the price of a falling stock could go back up.

In a long squeeze, there is an attempted liquidation of long positions by investors trying to reduce their losses. Being in a long position in terms of security such as a stock or bond means the holder owns the security and will profit if the price goes up rather than down unlike the short sellers. This is a more conventional practice in the art of investing.

This is typically explaining the world of cryptocurrency, where long holders can afford to hold on to their financial instrument while the price falls with the hope that it goes back up so as to garner profit.

The Difference Between A Short And A Long Squeeze

To make it easier, you can see the list of subtle differences between a long squeeze and a short squeeze;

  • In a short squeeze, the asset or financial instrument needs to be borrowed from a broker to be returned at a later date unlike in a long squeeze where the long holder owns the asset.
  • In a long squeeze, long holders can afford to sit and wait for a long time through a price fall unlike in a short squeeze where the short sellers need to cut their losses and buy immediately during a price rise
  • For a short squeeze to occur, there needs to be a price rise in stock whereas, for a long squeeze to occur, there needs to a fall in the price of the stock.
  • In a short squeeze, the trader who has taken short contracts has a legal obligation to settle with the promised shares unlike a trader in a long position who may have no such obligations.

How To Take Advantage Of A Market Squeeze?

Investors that are interested in market squeezes should know how to identify and take advantage of them in order to make profits and not lose. To take advantage of a market squeeze, investors need to be aware of the signs of a market squeeze.

Gathered here are a few signs of a market squeeze:

  • Rapid recovery of a falling stock.
  • The sharp increase in volatility or price range.
  • A rising market that suddenly and swiftly accelerates to extreme price rise and also a falling market that suddenly swiftly decelerates to extreme price fall.

Stock sellers that want to take advantage of a squeeze should be able to anticipate a drop in stocks price ahead of time. Short sellers should find companies that are misunderstood by the market to do their research and take advantage. An example is a company that is not disclosing its finances. Buy and sell walls are also a form of a market squeeze.

A sell wall is a tool leveraged by an individual to manipulate the price of a cryptocurrency downwards. When sell walls build, traders generally sell because they are made to think all other traders are selling, hence being squeezed out of their positions. And individual using the sell wall will generally buy a large amount of cryptocurrency at a lower price because a sell order has been set to prevent a higher sell order from being executed. After buying, the price will rise very rapidly once selling pressure is eradicated. A buy wall occurs when the amount of buy orders on a cryptocurrency far surpasses the amount of sell orders which is a good sign for traders. Day traders generally make profits during the buy wall.

Margin trading is almost like short trading, but this time, an individual or organization borrows money from a broker to buy or sell more stocks instead of borrowing stocks as it is in short trading. It is more like a short-term loan to increase the buying power. However, a margin account is needed to act as collateral in both short trading and margin trading.

Also related to the market squeeze is the options and futures trading. A futures trading involves a future contract which is an agreement between two parties to have the right to buy or sell an asset at a certain time and price in the future. The obligation is on both the buyer and seller to execute the contract. It’s usually for traders that don’t have the money but would have at a future date like the short sellers that borrow money from the stock lenders. Just like the futures trading is the options trading, with the difference being that there is no obligation between the parties to execute the contract at a later date.

In a Nutshell

In conclusion, aspiring investors should know how to take note of the signs and take advantage of a market squeeze. Near perfect timing is required to make short squeezing work, only experienced investors should engage in short selling. Short selling is very risky because, over time, most stocks appreciate in value. Ultimately, short sellers need to beware of short squeezes.

Thank you for reading through our short and long squeeze comprehensive coverages. We are glad to welcome you for more of such intuitive content, keep checking our site from time to time.

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