Definition of Short Squeeze
What is a Short Squeeze?
A "short squeeze" occurs when short-sellers rush to cover their positions due to a rapid increase in the price of a stock or futures contract.
Short squeezes generally occur in stocks that have small floats and a large number of short positions (relative to the float).
A "short squeeze" can be caused by any number of different reasons - generally speaking, the most common cause of a "short squeeze" is an unexpected piece of good news for a company. This results in people taking new positions in the company's stock, the price rising and short-sellers deciding that they want to get out of the stock. The short-covering only adds fuel to the fire, sending the shares even higher.
Example of a Short Squeeze: Volkswagen. Often referred to as the "mother of all short squeezes." This short squeeze temporarily gave Volkswagen the largest market capitalization of any company in the world.
Many hedge funds were short Volkswagen, and were caught off guard when Porsche announced that it had effectively gained control of 74% of Volkswagen's voting shares. There was a very short supply of Volkswagen shares with which to cover short positions with, leading the stock to soar over the period of a week as hedge funds desperately tried to cover their positions.
The unexpected news, combined with a very small float and large number of short positions, conspired to drive the shares through the roof. Some hedge funds are reported to have lost billions as a result of the squeeze.
Final Note: A limited supply of shares is crucial for a true short squeeze. You are not going to see a "short squeeze" in a stock like Microsoft, which has billions upon billions of shares in its float. If you have a 100k short position in Microsoft, you will not have a hard time covering your position.
However, if you are short 100k shares of a stock that has just five million shares in its float, you may find yourself having a hard time covering the position if the company announces an unexpected piece of good news. That is a "short squeeze".
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