What Is Short Squeeze?

The Concept of Short Squeeze

When the exchange rate suddenly rises, and bidders who were waiting for a decrease start to close their positions, a short squeeze occurs.  

How a Short Squeeze Is Formed

A short squeeze is, in simple words, a phenomenon that occurs as a result of a dense accumulation of open short positions. If the exchange rate rises, participants start closing short trades and buying tokens. The additional demand stimulates the price, and it increases even more. This leads to the active liquidation of short positions and an increase in losses of their holders. Panic and significant price fluctuations may occur in the market.

Short squeeze in trading allows for using participants’ short positions against them. A high-profile case occurred in 2020. Hedge fund Melvin Capital opened a huge number of short positions on the GameStop shares. It was a chain of stores on the verge of bankruptcy. Members of the WallStreetBets community tracked this trend and decided to save the company. To do this, they started actively buying GME shares. With the growing demand, the price also rushed upwards — in less than a month, the shares rose in price 20 times. The short sellers’ losses exceeded $19 billion.  

How to Protect Positions from Short Squeeze in Cryptocurrency Trading?

Understanding what a squeeze is and how it works, traders take measures to protect themselves from risks using several mechanisms:  

1. Stop order. It is a restriction that assumes automatic execution of the transaction when the price reaches a certain level. Such an order protects the short from complete liquidation (you can read more about what a stop loss and take profit are here).  
2. Hedging. A trader can reinsure themselves by opening a reverse (long) trade on the same cryptocurrency. This will minimize losses if the price goes up.  
3. Low leverage. Leverage allows you to trade with a larger amount of money than you have. However, you should remember that the lower the leverage, the less risk, and vice versa.  
4. Spot trades. This type of trading does not involve debt obligations between the exchange and the trader, which reduces the probability of losses.  

Who Wins and Who Loses from Short Squeezes? 

Having found out what a short squeeze is, you can easily determine that this phenomenon brings losses to those who open short positions and do not get out of them in time. Smaller losses will be incurred by those who used stop orders and repurchased assets at the beginning of the squeeze. The more time passes from the squeeze to the redemption, the bigger the losses will be.

Holders of long positions will benefit from a short squeeze because they can sell assets at a favorable price after their price rises.  

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