A short squeeze refers to a market situation where holders of short positions are forced to cover their positions due to a rising market price, leading to further price increases. This phenomenon typically occurs when there is significant selling pressure on an asset and a bearish market sentiment.
Here's an example to illustrate a short squeeze:
Let's say there is a stock with a highly bearish market sentiment, and many investors hold short positions, meaning they have borrowed and sold the stock in the hope of buying it back at a lower price to profit. However, if unexpected positive news or market changes occur, the stock price starts to rise.
As the price goes up, holders of short positions face tremendous pressure. To avoid further losses, they need to close their positions by buying back the stock they previously sold. However, with a large number of short positions in the market, these holders rush to buy the stock, creating a supply shortage. As a result, buy orders increase in the market, pushing the price even higher.
As the price continues to rise, more short position holders feel compelled to cover their positions, joining the market to buy the stock and avoid further losses. This chain reaction leads to a rapid increase in price, creating a short squeeze.
A short squeeze can result in significant price volatility and cause substantial losses for those holding short positions. However, it presents an opportunity for long position holders in the market to profit from the short squeeze phenomenon. The occurrence of a short squeeze is often associated with a shift in market sentiment and a significant presence of short positions.