If you trade in the market, or have even done a little research on trading, you’ve heard the term short squeeze. This is a technical move in the market that tends to lead to dramatic gains.
However, chasing a short squeeze can be a dangerous move for new comers. Nonetheless, the prospect of monumental gains on a single trade lures in the masses.
There are a few things that you should know about how these massive gain generators work if you plan on chasing down potential gains in multiples.
What Is A Short Squeeze
Before you attempt to hunt down the next short squeeze, it’s important that you know exactly what it is. It all starts with traders selling a stock short.
When a stock is sold short, it means that a trader believes that the value of the stock is going to fall. So, the trader pays to borrow shares of the stock. Once these shares are borrowed, they’re offloaded into the open market at the current trading price.
The hope is that the stock will fall in value. When this takes place, the short seller buys the borrowed shares back and returns them. The difference between the origial selling price and the repurchase price, minus fees, becomes the profit on the trade.
However, this move can go very bad for short sellers. The short seller must purchase shares back regardless of if the stock falls or climbs. When a stock climbs, short sellers can experience large losses.
This is when a short squeeze takes place. When a heavily shorted stock starts to head up, short sellers must buy shares to cover. The faster they buy, the more they cut the losses they take. This flood of short sellers covering their positions leads to dramatic increases in volume and price, or, the classic short squeeze.
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