A short squeeze is a trading term that happens when a stock that is heavily shorted all of a sudden gets positive news or some kind of catalyst which brings a lot of new buyers into the stock. When this happens, the stock is being bought up and the shorts are now forced to cover their positions (getting squeezed out), which then results in more buying that can cause a stock to go up very quickly and by a lot.
You can find short information on stocks through most financial sites like Yahoo and Google Finance. They list the short interest and the percentage short of the float along with the short interest ratio. The short interest ratio (SIR) measures the amount of shares short divided by the average daily trading volume.
So if the SIR is 3, then that means it would take 3 days at the average volume levels for shorts to buy back their shares. However, when a squeeze is underway the volume is usually increased by a lot so shorts could cover more quickly.
The important part to remember is that when a short squeeze is underway, you don’t want to be caught on the wrong side of it.
Trading A Short Squeeze
What also happens is new buyers are alerted when prices start to move which even further magnifies the buying and could cause a stock to go parabolic. A good example of this was Dryships ($DRYS) just a few weeks ago that ran up over 2,000% following the news that Trump won the election.
This stock was heavily shorted but with the surprise win, shares were back in favor and buyers drove the stock up causing shorts to cover and the stock to shoot up. Shares were trading below $5 per share but over the span of just 4 day, shares breached $100 per share!
Warrior Trading Pro Tip
A good way to avoid being caught in a short squeeze is to always place hard stops on your short positions, especially if you are holding them over night. Short squeezes can happen very quickly and can move the stock more dramatically than normal rally’s, causing huge losses if you aren’t paying attention.