Short Squeezes Explained

A short squeeze is a market event that drives up shares of a stock that’s being shorted. In this highly risky maneuver, short sellers are essentially forced to try to exit their bearish position quickly in order to minimize losses amidst the dramatic surge in the share price.

One of the most well-known short squeezes in recent history was the GameStop trading frenzy that occurred in 2021, and again on a smaller scale in 2024. Both were inspired by viral social media posts, and the so-called “meme stock” phenomenon influenced price surges in other stocks, as well, including those of AMC, Koss Corp., and BlackBerry in 2021. Earlier in 2008, Volkswagen briefly became the most valuable stock globally as a result of a short squeeze.

Learn more about short squeezes and how they may influence a stock’s price and volatility.

What Is a Short Squeeze?

As mentioned, a short squeeze is an event in the market that involves short sellers having to quickly close out their positions. Because these investors have to actually buy back shares they’ve lent out, this may drive dramatic gains in the share price.

There are many investors, both retail and institutional, who use short selling to speculate that a given stock will go down over a fixed period of time. But short selling is incredibly risky, as stock prices have historically tended to drift upward. And timing a bearish position can also be tricky. Even if an investor has good reason to believe that a company’s shares will fall, it could be some time before they actually do.

What Causes Short Squeezes?

To understand how short squeezes occur, you first have to understand how shorting a stock works. An investor may short a stock when they believe its price will decline. To sell a stock short, an investor first borrows shares from a broker, and sells them in the open market. At a later time, the investor buys back the shares in order to return them to the original lender.

If the stock goes down between the time they borrow the stock and return it to the broker, the investor may make money. That’s because they can pocket the difference between the higher selling price and the lower purchase price, minus interest owed and transaction costs.

And if those short investors borrow a stock that goes up instead of down, they lose money.

Example of Short Selling

Let’s look at a hypothetical case of a short sale. Let’s say an investor borrows a stock that’s trading at $10 with an agreement to pay back the shares in 90 days.

The investor then sells the stock for $10. Then 90 days later, if the stock is trading at $5, they can buy back the number of shares they borrowed and return them to the lender, capturing the $5 per share profit (minus interest and fees).

Example of Short Squeeze

Now, let’s use this example to look at a short squeeze. Let’s say the investor borrows the stock, again, that’s trading at $10, with an agreement to pay back the shares in 90 days.

This time, however, the share price shoots up to $15. The investor still has to buy the shares they borrowed and return them to the lender. But other investors are also trying to cover their shorts, so there’s a shortage of shares in the market to buy back.

The shortage causes the stock’s price to jump even higher to $20, which in turn triggers other short sellers to close their positions, leading to a buying frenzy and a short squeeze.

Theoretically, there’s no limit to how much money short sellers can lose. When an investor is short a stock and wrong in their assumption, the share prices can go infinitely higher.

Recommended: How Low Can a Stock Go?

Famous Short Squeezes

One famous example of a short squeeze was that of GameStop, which first occurred in 2021, when electronics retailer GameStop saw its shares jump more than 1,000% in a few weeks as a wide range of investors looked to take advantage of the high number of short sellers in the stock.

This was perhaps one of the most well-known of the meme stock phenomena that overtook the market that year, but it wasn’t the only one. Shares of AMC, Bed Bath & Beyond, Koss Corp., and other companies’ stocks spiked upward during the meme-stock frenzy that year.

Another example occurred in 2008, when automaker Volkswagen briefly became the world’s most valuable stock by market cap when it became known that Porsche was increasing its stake in its fellow German carmaker.

What’s a Long Squeeze?

By contrast, a long squeeze is when short sellers drive down the price of a stock or asset until the bullish investors begin to sell their positions in response, driving the price lower still. It can be helpful to review short positions vs long positions to get a deeper understanding of a long squeeze.

What Was the MOASS?

The “MOASS” is an acronym for mother of all short squeezes. And it’s more or less exactly what it sounds like: a monstrous short squeeze event in the market.

The short squeeze involving GameStop shares in 2021 is perhaps the best and most recent example of a MOASS, though companies such as AMC and Koss Corp., mentioned above, experienced similar phenomena at the time.

Many institutional investors had shorted GameStop stock, anticipating that its value would fall, but social coordination of day traders drove up demand for the stock and its value. This “squeezed” the short sellers and caused many big firms to lose significant amounts of money on their positions.

How to Identify a Short Squeeze

Given the high risk of significant loss for short sellers in a short squeeze, learning how to identify signs of a potential short squeeze may help to reduce risk. On the other side of the equation, some investors may buy into a short squeeze to attempt to benefit from a quickly rising stock price, though this also comes with substantial risk. Buyers can quickly lose interest in stocks of companies that lack the fundamentals to support their market price.

While short squeezes are not entirely common and can be difficult to predict, metrics such as short interest and days to cover may help signal that a short squeeze could be imminent.

Short Interest

To identify the potential for a short squeeze, traders may start by surveying the markets for stocks that have garnered substantial interest from short sellers. This factor is often called short interest, and as a metric, it represents the number of a company’s shares that have been sold short but not yet returned to the lender.

Traders know that unless the short sellers of those shares can wait, hedge, or manage risk, they’ll have to buy back shares — at virtually any price — to return them to the lender.

There are two ways to understand short interest:

•   One is the short interest percentage, which shows how many of a company’s overall shares are currently shorted. A higher number means that more short sellers will be bidding up the stock to buy it back if the stock rises.

•   The second metric is the short interest ratio, also called the days-to-cover ratio, which shows how much short sellers are responsible for a stock’s daily trading volume. A higher ratio can indicate that it may take more time for short sellers to buy back their shares, making it more likely for a rapid price surge to occur.

Stocks with a high short interest and high days-to-cover ratio are potentially vulnerable to a short squeeze. If opportunistic traders identify stocks that seem like short-squeeze candidates, they may buy the stocks outright and watch those key metrics, along with the news, to decide when to sell. Again, this strategy can be highly risky given the chaotic price swings that may occur. Short squeezes can make a stock shoot up, but those returns often evaporate quickly.

Short Squeezes vs Naked Shorts

A short squeeze is a rapid price increase in a heavily shorted stock. It’s essentially a chain reaction that results from numerous short sellers buying the shorted stock to cut their losses, pushing the price increasingly upward. The result can be substantial losses, as mentioned above.

A naked short is a type of illegal trade that involves an investor selling shares they don’t actually own, borrow, or otherwise have possession of. This leaves the trader vulnerable, or “naked,” in the event that a trade goes south, and is highly risky. It’s also considered unethical since it can create volatility and distort prices.

Risks of a Short Squeeze

While short-squeeze investments can produce eye-popping returns in the short term, they come with real risks for individual investors and institutions.

Risks for Investors

For investors, perhaps the biggest risk of a short squeeze is that they’ll get caught on the wrong side of one and lose some money. Obviously, that’s a risk for institutions as well, but individual investors likely don’t have as many resources on hand to try and recover.

Similarly, investors may misread the room — that is, not quite understand what’s happening in the market and misjudge their position. They’ll also need to be vigilant in watching their positions to make sure they change those positions at the right time.

Risks for Institutions

Most of the risks involved with short squeezes for individual investors hold true for institutions, too.

For instance, the risks involved with stocks themselves include the fact that stocks with a high short interest number may be undervalued or misunderstood, or they may simply be failing businesses. And if there’s no good news or market interest, they may continue to sink.

At the same time, the price increases caused by short squeezes are short-lived. Once the short sellers have paid back their lenders, the market runs out of buyers who will pay any price for that stock. And the share prices often fall as quickly as they rose. The danger to traders in a short squeeze is that they may be forced to buy back shares at peak prices, exposing them to potentially unlimited losses.

The Takeaway

A short squeeze is a market phenomenon in which investors inadvertently bid up the price of a heavily shorted stock, while trying to get out of their bearish positions. In order to buy the stocks that investors borrow to sell short, those investors must buy the stock at ever-increasing values.

Short selling is an advanced trading strategy that investors may use to speculate on the direction of an asset’s price, but it also comes with high risk, including the potential of being involved in a short squeeze.

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FAQ

Are short squeezes legal?

Short squeezes are a natural occurrence in the stock market, but market manipulation is illegal. As the SEC says, “abusive short sale practices are illegal,” and that may play into short squeezes. As such, it’s a gray area.

What is the biggest short squeeze of all time?

While the Volkswagen short squeeze in 2008 was one of the largest of all time, the 2021 short squeezes of GameStop along with AMC, Koss, and others, were some of the most dramatic and notable short squeezes in history. These events highlighted how coordinated buying and market dynamics can drive rapid price increases.

How high can a short squeeze go?

Theoretically, there’s no limit on how high a stock can go, and accordingly, how high a short squeeze can go. However, such price surges are often driven by short-term dynamics and may not be sustained.

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