A squeeze is the market price temporarily moving against its longer term direction, by a larger amount than would usually be expected, and then continuing moving in its longer term direction. A short squeeze is therefore the market price moving temporarily upwards by an amount that would not be expected if the market was going to continue moving downwards.
Short Squeeze Example
A short squeeze typically occurs as shown in the example chart, and includes the following components:
- The market is in a significant downward trend (i.e. the market is moving downwards over the long term),
- the market then pauses and moves temporarily sideways,
- at the end of the sideways price movement, the market moves temporarily upwards by an amount that would not be expected if the market was going to continue moving downwards,
- the market then continues moving downwards and resumes the original downward trend.
Cause and Effect
A short squeeze can happen purposefully (e.g. institutional traders (with significant amounts of trading capital) could temporarily move the market price against its long term direction (i.e. upwards) so as to make a short trade at a favorable price), or as a result of a news release (e.g. a positive news release could cause the market price to temporarily move upwards in response to the news release before continuing downwards regardless of the news release). Whatever the reason for a short squeeze, the result is often that short trades reach their stop losses, and are squeezed out of the market (hence the name short squeeze).
In order to avoid a short trade falling victim to a short squeeze, a trader either needs to know that a short squeeze is occurring, or place their stop loss so that it would not be affected by a short squeeze if one occurs. Knowing that a short squeeze is likely to occur requires being familiar with the market being traded and a lot of experience watching financial market price movement. Placing a stop loss outside the scope of a short squeeze requires a trading technique or trading system that is designed according to the underlying principles of financial market price movement (which would take any potential short squeezes into account as a matter of course).
Professional traders usually have both options available to them (i.e. professional traders have both the experience to know when a short squeeze is likely to occur, and professional traders are trading correctly (i.e. according to the underlying principles of financial market price movement)). New traders sometimes have one option available to them (i.e. new traders do not have the experience to know when a short squeeze is likely to occur, but new traders could be trading correctly (assuming that they have learned a professional trading technique or trading system)), and new traders often no options available to them (i.e. new traders often do not have the experience to know that a short squeeze is likely to occur, and new traders are often not trading correctly). If a new trader finds that their short trades often fall victim to short squeezes, they should consider their trading technique or trading system, as they are likely to be trading incorrectly (and possibly trading according to a trading gimmick rather than a trading technique or trading system).
