Short Squeeze Mechanics:
How to Spot & Trade Them

Understanding the Market Forces That Trigger Explosive Moves

Alright, so everyone’s heard of the phrase “Short Squeeze”.

But what does it really mean, and what are the mechanics behind it?

First, I want to differentiate slightly between a stock short squeeze and a squeeze on, say, the indices (today’s topic).

A stock short squeeze usually happens when the short float is very high, the stock is ripping to highs, and sometimes the shares loaned out are being recalled.

Check out The VW Short Squeeze for a great example:

🔗 Volkswagen Short Squeeze, 2008

“Hedge-fund managers reportedly compared the Porsche disclosure to a ‘nuclear bomb going off in our faces.’”

Ha! Well, that doesn’t leave any doubt about the impact!!

Anyway, back to the indices…

SHORT SQUEEZE MECHANICS

Ok, so no one really knows how or why other participants are positioned.

For every buyer, there must be a seller… throw in hedging, options, and HFTs, and you have a smorgasbord of players with different incentives and objectives.

But in simple terms, here’s a good way to look at the mechanics of a short squeeze:

  • Bears see a break lower and start to pile onto the sell side, liquidating longs and initiating fresh short positions.
  • The market rebounds quickly, and it becomes clear that they’ve shorted into the hole.
  • So, not only do you have shorts in pain, not thinking about selling more, at best waiting to see what happens, or more likely buying to reduce their risk…
  • Plus, you have sidelined bulls who’ve been waiting for a signal to press… they get long too.
  • Mid-term longs start to buy more.
  • Short-term traders start buying specifically because they see the short squeeze unfolding.

Result?

Very few sellers and an extreme supply/demand imbalance (for now).

Think about how price moves, if buyers are willing to pay higher and higher prices and sellers are happy to wait for better prices, you have a perfect storm.

Only when buyers back off the throttle and sellers start to think they need to get more aggressive with their offloads does price stall or reverse.

We don’t get these often, but when we do, I think it’s a potential golden opportunity.

When you look at a chart, ask yourself
“Who is hurting the most here”

If there’s been a dip that’s reversed hard, it could be the shorts in a vice, and they need to cover…

Keep it on your radar.