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Your Introduction to the Short Squeeze


October 25, 2021 ( Newswire) If you have heard of hedge funds and hedge managers, then you have probably also heard of shorting stocks as a part of the basics of trading. This is a process in the investment world which involves speculating on stock prices as they might rise and fall over time. If you're correct in your predictions, you can attempt to determine which stocks and securities are going to lose value, and which will gain it.

Unlike other investors who tend to bet on the price of an asset going up, people who use shorting stocks to make a profit focus on the other direction. They look for assets likely to lose value, and invest quickly before the price begins to drop. When the cost does go down significantly, the investor can then make a profit by buying back what they need at a much lower price. This might sound like a good idea, but there are some dangers too, such as the risk of something might squeeze the short stock.

What is a Short Squeeze?

One of the more worrying aspects of trading short stocks is that you never know for certain if your predictions are going to be correct. If you sell something and the price of that security suddenly goes up instead of down, you could stand to lose plenty of money. Because the value of a security rises by an unlimited amount, there is essentially no limit on what you can lose.

The impact of a stock squeeze can be huge on buyers. It happens when an asset or a stock suddenly sees a massive increase in price. This might happen because of social or political events, or simply because customers have found out new information about a business, prompting a rise in demand. The short squeeze pushes investors using short selling to buy back what they need as quickly as possible. The demand to buy the securities back before the price increases even further causes panic in the marketplace, and the price will often increase even more based on this scramble for assets. There are even occasions where a seller may not be able to regain the stock they sold.

Limiting Losses

Ultimately, short sellers only borrow the shares of an asset they believe is going to drop in price for a short time. No asset rises or falls in price forever, so the aim is to sell the asset at the highest possible price, and buy it back at a lower price, before any losses occur. If a squeeze happens which causes the price to suddenly increase, most professionals will need to cut their losses by buying as soon as they can. The term squeeze is used because it squeezes short stock sellers out of their positions.

Short squeezes often happen only for a short period of time. In some cases, the price of a stock might increase drastically, and then fall again within the same set of months. However, the short seller can't always wait around to see if the problem will resolve itself. If the change isn't just temporary, then the investor could face more risk by waiting.

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