What is a short squeeze?

-A short squeeze happens when the price of an asset sharply increases due to a lot of short sellers being forced out of their positions.

Short sellers are betting that the price of an asset will decline. If the price rises instead, short positions start to amass an unrealized loss. 

-As the price goes up, short sellers may be forced to close their positions. This can occur via stop-loss triggers, liquidations (for margin and futures contracts). It can also happen simply because traders manually close their positions to avoid even greater losses.

How do short sellers close their positions?

- They buy. This is why a short squeeze results in a sharp price spike. As short sellers close their positions, a cascading effect of buy orders adds more fuel to the fire. As such, a short squeeze is typically accompanied by an equivalent spike in trading volume.

-The larger the short interest is, the easier it is to trap short sellers and force them to close their positions. In other words, the more liquidity there is to trap, the greater the increase in volatility may be thanks to a short squeeze. In this sense, a short squeeze is a temporary increase in demand while a decrease in supply.

-The opposite of a short squeeze is a long squeeze – though it’s less common. A long squeeze is a similar effect that happens when longs get trapped by cascading selling pressure, leading to a sharp downward price spike.

How does a short squeeze happen?

1.A short squeeze happens when there is a sudden increase in buying pressure. However, what makes a short squeeze a particularly volatile event is the sudden rush to quickly cover short positions (via buy orders). This includes many stop-loss orders triggering at a significant price level, and many short sellers manually closing their positions at the same time.

2.A short squeeze can happen in essentially any financial market where a short position can be taken. At the same time, the lack of options to short a market can also lead to large price bubbles. After all, if there’s no good way to bet against an asset, it may keep going up for an extended period.

3.A prerequisite of a short squeeze can be a majority of short positions over long positions. Naturally, if there are significantly more short positions than long positions, there’s more liquidity available to fuel the fire. This is why the long/short ratio can be a useful tool for traders who want to keep an eye on market sentiment.

4.Some advanced traders will look for potential short squeeze opportunities to go long and profit off the quick spike in price. This strategy will include accumulating a position before the squeeze happens and using the quick spike to sell at a higher price.

Risks of short squeeze trading

1.During a short squeeze, short-sellers run the risk of losing a substantial amount of money if the crypto price continues to increase.

2. A large short interest can go either way, meaning that the crypto price can still increase just as much as it can decrease. Short interest is an indicator that certain investors believe that the crypto price will decline.

3.Timing is key

Predicting the start or end of a short squeeze is extremely challenging. Often, by the time it’s clear a short squeeze is happening, the stock price may already be high. Investors who buy in late could risk paying at the peak and losing money when the price falls.

4.High volatility

 Crypto in a short squeeze can have rapid price swings within minutes or hours. This level of volatility can make it hard to decide when to buy or sell, as prices can drop just as quickly as they rise.

5.Risk vs. reward

While there is potential for profit, the risk of significant losses is equally high. Short squeeze trades often favor those who time it perfectly, but for others, they can lead to substantial losses if the price drops back to normal levels.