What is a short squeeze?

A short squeeze is a market phenomenon where the price of a stock increases rapidly due to a sudden and significant increase in demand, often triggered by a perceived shift in the stock's fundamentals or technical indicators. This increase in price forces traders who had sold short the stock to buy it at the higher price to cover their short positions, thus creating a self-reinforcing cycle that can propel the stock's price even further.

1. Definition and Causes: A short squeeze occurs when a stock with a substantial number of short sellers unexpectedly rises in price. This rise can be triggered by various factors such as positive earnings reports, favorable news, or technical indicators suggesting a reversal in the stock's downward trend.
2. Mechanism: Short sellers initially bet on the stock's price declining, borrowing shares to sell them short. If the stock's price rises instead, short sellers face the risk of having to buy back the shares at a higher price to cover their short positions. This buying pressure from short sellers to close their positions can amplify the stock's price increase.
3. Characteristics: Short squeezes are characterized by a rapid and significant increase in a stock's price, often accompanied by high trading volume. They can lead to a stock's price far exceeding its intrinsic value, driven by market sentiment rather than fundamental factors.
4. Examples: Notable examples of short squeezes include Tesla in early 2020, which was the most-shorted stock on U.S. exchanges with over 18% of its outstanding stock in short positions, and Volkswagen during the 2008 financial crisis, which experienced a significant short squeeze due to a combination of factors including government bailouts and a shift in market sentiment.
5. Risks and Implications: Short squeezes can be highly profitable for investors who are positioned long, but they also pose risks, particularly for short sellers who may suffer substantial losses if they are unable to cover their short positions or if the stock's price rises further than anticipated.

In summary, a short squeeze is a rapid and dramatic increase in a stock's price driven by a sudden shift in market sentiment and the ensuing actions of short sellers to cover their positions, often leading to further price increases as the cycle continues.