Short Selling and Short Squeeze

Short selling (shorting a stock) is when many investors bet against a stock price rise in the future. Shorting is performed by borrowing shares from other investors in the hope that the stock price will fall. Therefore, short-sellers are hoping to buy back the stock (to return them to the real owner) at a lower price and cash the profit (difference in the price). However, if their prediction of price movement is wrong, they will be forced to buy back stock at a higher price and lose money.

Short selling can be one of the biggest catalysts for a short squeeze. A short squeeze is when a stock price with many short-seller interests starts surging. As a result, panic buying starts, and many short sellers start buying back the stock to cut their losses. This results in a more surge in the price and encourages more retail investors to buy. The best example of a short squeeze is Tesla in which it had many of its stocks in short position by the end of 2019. However, its future outlook was positive (clean energy and electric cars). Therefore, its price starts surging a lot during 2020.

There are many risks associated with short selling. The potential for making a profit is limited, but the potential to lose money is theoretically unlimited. For example, a stock with the current price of $25 can go to $0 ,but it can also go up to $100, $200, or $1000. There are a few measures to evaluate the risk associated with shorting and short squeeze. Two of these factors are short interest and short-interest ratio. Short interest is the ratio of outstanding stocks being shorted. For example, if a company has 1 million outstanding shares, and 200k of them are shorted, then the short interest is 20%. The short-interest ratio is the number of shorted stocks divided by the trading volume. This indicates the number of days it takes for short sellers to buy back the shorted positions. For example, for a stock with 200k shorted positions and a daily trading volume of 20k, 10 days will be required for short sellers to buy back all of their shorted stocks. A higher trading volume indicates that it takes short time for the short sellers to buy back the stocks.

You can benefit from a short squeeze by identifying them and following their news. The best places to find this information are Wallstreetbets (Reddit) and The ideal time to jump on a shorted stock is at the beginning of a price surge. For example, imagine a pharma company that is not profitable at the moment. If the company develops a blockbuster drug in the future, it may result in a short squeeze.

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