A short squeeze is when a big rally to the upside happens during a downtrend in a market due to a lack of sellers at lower prices combined with the pressure on current short sellers to be forced to buy to cover due to the reversal in the market trend creating upside price pressure.

Short squeezes gain momentum as more and more short sellers are forced to buy to cover their positions at higher and higher prices resulting in increased trading volume on the reversal out of the downtrend. The pressure on the short sellers to buy back their positions can be amplified by margin calls, trailing stops, and stop losses being triggered. The short sellers create buying pressure because they have to buy back the shares or contracts they are short to cover at some point.

A short squeeze is more likely to happen and can be more powerful in stocks with small market capitalization and small floats and also in thinly traded futures markets with low volume. Short squeezes have a higher probability to happen when a large amount of a stock’s float is short, a market has an extremely high percentage of bearish sentiment, or sellers simply are exhausted after a long downtrend and find prices with no sellers left. When a market reaches maximum bearish sentiment at a price level where people prefer to hold their positions instead of sell then a short squeeze is set up to get underway.

Short Squeeze
ETSY short squeeze after the September 6th low at the oversold 30 RSI. MACD bullish crossover off the lows.

Chart courtesy of StockCharts.com

By Steve Burns

After a lifelong fascination with financial markets, Steve began investing in 1993 and trading his accounts in 1995. It was love at first trade. After more than 30 successful years in the markets, Steve now dedicates his time to helping traders improve their psychology and profitability. New Trader U offers an extensive blog resource with more than 4,000 original articles, online courses, and best-selling books covering various topics.