You can assess sentiment using indicators such as volume, Commitment of Traders (CoT) and the VIX. Right before a short squeeze occurs, the attitude toward the stock will change from negative to a more positive outlook.
Learn more about how to short a stock What causes a short squeeze?Ī short squeeze is caused by a change in the opinion of investors and traders – they go from an overwhelmingly negative view to a positive one. If enough market participants act the same way, the security will surge higher, forcing more and more short sellers to close their trades at a loss. This is what happens in a short squeeze, and then some – the market turns to the upside, so in order to limit their loss, short sellers rush to close their position. However, if the market rises instead, then the seller will be forced to buy back the shares at a higher price for a loss. The difference between the initial sell price and a lower buy price represents the profit. When a security is shorted, traders effectively borrow shares from their broker in order to sell them on, with the intention of buying it back at a later date at a lower price. The price increase encourages more buyers, which promotes an often-irrational bullish sentiment, and literally ‘squeezes’ sellers out of the market. A short squeeze is the term to describe a rapid rise in price that forces traders who have shorted a security to buy at a loss.