Short squeeze
A short squeeze is a financial phenomenon that occurs in the stock market, primarily stemming from the practice of short selling. In short selling, an investor borrows shares of a stock with the expectation that its price will decline. They sell the borrowed shares, hoping to repurchase them at a lower price to return to the lender, thus making a profit. However, a short squeeze happens when a stock price unexpectedly rises instead of falls, prompting short sellers to panic. As these investors rush to buy back shares to mitigate their losses, their collective buying can lead to a dramatic increase in the stock price, often far exceeding initial expectations. This situation can be exacerbated by other investors speculating on the upward momentum, further inflating the stock's value. Short squeezes can create significant volatility, resulting in substantial financial gains for some, while leading to devastating losses for unsuccessful short sellers. Financial experts often caution against short selling due to its inherent risks, as potential losses are theoretically unlimited. Notable examples of short squeezes include the dramatic rise in GameStop's stock in early 2021, which surged more than 2,300% amid a flurry of short selling and subsequent panic buying.
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Short squeeze
A short squeeze is a financial activity that may occur in the stock market, such as in the GameStop episode of 2021. Short squeezing is based in the stock technique of short selling, or “shorting,” in which investors attempt to profit on stocks they expect to fall in value. Short sellers borrow stocks declining in price, sell them, and attempt to repurchase them at lower prices when they are obligated to return them to their actual owners. A short squeeze occurs during periods of mass short selling when a stock rises instead of falls. This unexpected activity causes panic buying and speculative buying that causes the stock price to artificially rise to an enormous degree.
Overview
The short squeeze is rooted in a stock market investment approach known as short selling. In short selling, or “shorting,” an investor predicts that a stock will lose value and tries to profit on this expected decline. For example, Investor A may borrow shares of a stock from Investor B, with the promise to return them. Investor A proceeds to sell the borrowed stocks for their current value and keeps the money, hoping that the stock price will soon fall. Upon the fall of the stock price, Investor A repurchases an equal amount of shares at the newly reduced price, which Investor A then returns to the rightful owner, Investor B. If the process takes place as anticipated, Investor A has made a profit through the sale of the borrowed stock.
A short squeeze occurs when many people attempt to short trade at the same time. Many investors borrow shares of a given stock with the promise to return them, with the unspoken expectation that the stock price will fall. However, in the case of a short squeeze, the price of the borrowed stock rises instead of falls. Short-seller investors, seeing their plan backfiring and now anticipating losses instead of profits, tend to panic. They rush to repurchase the recently sold shares, even at elevated prices, in the hope of reducing even-greater losses they expect to incur if they wait.
The panic-buying may continue and expand as increasing numbers of short sellers attempt to extricate themselves from further losses. By this time, due to the artificial manipulations that had taken place, a stock that may have been deeply troubled and widely expected to fail may instead rise at an astounding rate. The situation may be compounded when other investors, known as speculators, begin buying into the rising stock. These speculators invest in the stock hoping to capitalize on its sudden rise due to the short sellers’ panic buying.
Short squeezing may play havoc on a stock and degrade faith in the stability of the stock market. It may also lead to dreadful financial repercussions for investors. An episode of short squeezing of the declining GameStop stock in 2021 caused the stock to rapidly rise more than 2,300 percent. This created massive wealth for some but also led to financial ruin for many unsuccessful short sellers. Financial experts generally warn investors to avoid short selling and short squeezing because the upsides are limited but the downsides are basically limitless. In other words, a stock can only fall to a value of zero, but it could theoretically rise toward infinity, meaning that people obligated to repurchase borrowed stocks may face prohibitively enormous costs to do so.
Bibliography
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