INVESTING EXPLAINED: What you need to know about a short squeeze – when short sellers scramble to cover their positions, to limit their losses
In this series, we bust the jargon and explain a popular investing term or theme. Here it’s short squeeze.
What is this?
We are talking about a stock market phenomenon, not a romantic relationship of brief duration.
When investors believe the price of a share is set to tumble, they will sell that share in a process called shorting.
These speculators borrow a parcel of the shares from a third party – who receives a fee – in the hope that they will be able to buy back the shares at a lower price, so turning a profit. However, the best-laid plans can go awry, since the shares may surge rather than decline.
The price may rise sharply, as squeezed short sellers scramble to cover their positions, attempting to limit their losses.
Putting a squeeze on: The best-laid plans can go awry, since the shares may surge rather than decline
Why would the price go up then?
There are a number of reasons. The short sellers may believe that the company in question is set to deliver profit figures that are worse than forecast, or reveal that current trading is disappointing.
But the results may be unexpectedly good. Even if the news is bad, this may have a negligible effect on the share price.
There are also contrarian investors who monitor which shares are being shorted and buy them in the hope of a benefiting from a short squeeze.
Are UK shares being shorted?
Yes they are. The list includes Asos, Barratt Developments, Currys – and Ocado.
However, Ocado is currently at the centre of a short squeeze in the wake of rumours of a bid from Amazon.
Any famous short squeezes?
Plenty. In 1923, Clarence Saunders, founder of the Piggly Wiggly supermarket chain, tried to foil short sellers by borrowing from banks to buy the firm’s shares.
But Saunders was finally forced into bankruptcy.
In 2008, short sellers targeted Volkswagen, calculating that a rumoured deal with Porsche would not take place.
When Porsche revealed that it had built up a stake in Volkwagen, the car maker’s shares leapt from €211 to €1,000 within two days, making it, briefly, the world’s most valuable company. The GameStop saga is the most celebrated example – to date – of recent times.
Why is that?
Eat The Rich: The GameStop Saga, a Netflix series, tells the story of how, in 2021, amateur traders on platforms such as Reddit took on Wall Street professionals by buying shares in this low-rated video game store. Lockdown boredom drove much of the buying.
GameStop shares rose 1500 per cent in a short squeeze, which raised fears that the whole financial system was under threat. Tesla boss Elon Musk got involved, becoming an anti-capitalist hero in the eyes of some.
Why is Tesla in a short squeeze?
Tesla’s shares are up by 135 per cent this year, to the chagrin of the short sellers who thought that the rally would be short-lived, but are now facing big losses.
There is some optimism that the Tesla price could return to $314, its high of 2022, amid renewed confidence about the electric vehicle maker’s prospects.
The mood may change if Musk goes ahead with his cage fight against Meta boss Mark Zuckerberg, but who knows?