June 9, 2021

What is a Short Squeeze?

The big short squeeze

A short squeeze is an unusual occurrence that causes a stocks or securities price to increase rapidly. For a short squeeze to happen, there must be many short sellers holding a position on that specific stock. What causes the short squeeze is when the price of the stock suddenly jumps extremely high, and the people that had previously held a short position on the stock, decide to give up and sell.

What is Short Selling?

To keep it short, (pun intended), short selling is when a trader bets against the stock going up, but instead that it will go down. It takes away what the general population usually thinks of when mentioning stock trading in the phrase “buy low, sell high” but it is a common position to take while trading.

In addition, it is not just betting that the stock will go down that makes it short selling, the trader also borrows shares of the stock that they believe will drop in price in order to buy them after they fall, and this is when things can get a little crazy.

How Does Short Selling Lead to a Short Squeeze?

When you short a stock you have an expiration date on the held position, when the stock unexpectedly goes up, you will probably decide to cut your losses and sell to save yourself from losing as much money as you can. Thus, short sellers are being “squeezed” out of their positions.

This what happens when you short the stock and you were wrong and the price went up instead of going down as you predicted, thus you are forced to buy the stock at a higher price and pay the difference between the position you held and what the stock is worth at the time.

When this occurs, and the stock’s price continues to go up it can cause a commotion, and the more people that let go of their short positions, while in the meantime, other traders also buy the stock, the higher the price of the stock goes up, causing a short squeeze.

On the other hand, if the short sellers are right, they return the shares and pocket the difference between the price they believed the stock was going to be at and the actual sale price.

Examples of a Short Squeeze

GameStop Short Squeeze

The GameStop short squeeze took the stock market by storm and made the stock market mainstream news. In the GameStop short squeeze, hedge fund managers who shorted GameStop had to cut their losses and lost billions of dollars to their clients because Reddit users who did not want GameStop to go bankrupt decided to buy and buy the stock, causing an extremely popular short squeeze and causing everyday joes to make a lot of money while the short holders did not.

As well, what made the GameStop short squeeze even more popular was the fact that for the first time every day people were making money off the “big guys,” possibly paving the way for short selling to become illegal one day as such activities like the GameStop short squeeze can cause an economic market crash, hence why it was temporally illegal to short squeeze back in 2008 during the recession.

AMC Short Squeeze

Currently in the market, AMC stock has been on the rise even with short selling. As of recently June 8^th, AMC closed at $55. 05. Experts are saying an AMC short squeeze will occur just like GameStop, and they are extremely excited about the profit potential. As of right now, AMC Entertainment continues to be the most heavily shorted stock in the market, and retail investors are holding on while hedge funds and short sellers are being bled dry anxiously dreading an upcoming AMC short squeeze.

In addition, like GameStop, AMC Entertainment was thought of being a dead-end but now with the stocks up, and the reopening of all AMC theaters after the pandemic, they are doing better than ever.

According to experts, short sellers are currently running out of borrowed shares, and they are losing money fast. Those with stocks of AMC will probably be seeing the biggest short squeeze the stock market has ever seen!

Brief History of Short Selling

In 1934, Congress enacted the Securities and Exchange Act, and short selling was one of its biggest issues, but they made no rulings on it. Instead, Congress gave full authority to the SEC is hoping to regulate short selling and prevent it from being abused. Then, in 1937, the SEC adopted what is known as the Uptick Rule, which states that traders can legally short a stock only if it is done during an uptick price on a previous sale.

On the other hand, short sales on down sticks were not allowed, and this prevented short selling at extremely low prices which can drive down a stock’s prices artificially. Still, many policymakers and the public thought it was not fair to profit from the losses of others in the market, especially since short sales increase when the market is declining, further proving that others benefit from the loss of others, as in the 2008 recession.

Throughout the years after, the SEC continued to do investigations until 2007 they eliminated the Uptick Rule but following the recession, many regulators are calling for the reinstatement of the Uptick Rule. Today, with the growing popularity of the GameStop short squeeze and the AMC short squeeze we do not know what the SEC may decide to do.

Should Short Selling be Illegal?

Again, with short selling being immensely popular in the stock market and regular news, people have been wondering if short selling should be illegal because of the economic effects it can have. In reality, short selling seems like it should be illegal to the ones that do not usually benefit from it. The stock market like the real world, is a game and not everyone has the same advantages and/or plays fairly, and many times people bend the rules. So, if you think you might be in a better position if you short a stock, then as a trader with the right trading plan, you do what you think is best for you. After all, it is better to be a bull than a bear.