Excursus: The role of hedge funds

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A short squeeze does not only affect small investors, but also hedge funds. The answer to this is very simple. A pension fund or a hedge fund always lends shares to an online broker in exchange for a certain amount of money. This online broker can in turn lend the shares to an investor in exchange for money. When too many small investors wanted to buy the shares, the hedge funds got into trouble and some brokers even stopped trading.

Other hedge funds speculate on the insolvency or bankruptcy of the companies. With short selling they bet on falling prices. The mass of small investors now pushes the price up and the hedge fund has to buy back the shares on the market.

For this reason, hedge funds also suffered extremely from the short squeeze in the GameStop case and had to suffer losses. Some hedge funds were even on the verge of bankruptcy or went bankrupt due to the large number of long positions by small investors.

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What are the causes of a short squeeze?

Now you know what a short squeeze is. But how does it actually occur? A short squeeze does not have much to do with trading analyses or other key figures. Rather, a short squeeze is caused by the reaction of market participants to each other. A typical market in https://exnesslatam.com/cuenta-pro/ is always initially balanced. So the bulls and bears in the market balance each other out and the demand and supply remain in equilibrium. News, press releases or a movement in the market can then cause the price to rise or fall. Often, however, a short squeeze occurs when the price is very low and investors see an opportunity in the price trend. In this case, the investors go long and with them the prices and the demand for the share rise.

During this time, the prices rise more and more and climb upwards. The short positions come under pressure here. While the investors buy back the shares in this process, the long investors buy even more shares. Then there is a price explosion, also called stock recall, and the prices rise so much that the short sellers lose.

So we hold that a short squeeze can arise from the following causes:

News from the company that could mean a falling share price.
Economic news or fundamental news about the monetary policy of a particular currency, which could lose value.
Stop loss orders are pulled further down by investors in order to hedge themselves
Herd instinct kicks in and the pressure is intensified by online social trading platforms

How to identify a short squeeze

As an investor it is important to know when short squeezes occur. A risk ratio can provide information about this. This is called the short interest ratio. This ratio provides important insights into a market. It shows the ratio of all short sales in relation to the average daily turnover. What can you as a trader or investor read from this? You can see approximately how many days it takes until the short sellers have to buy back the positions.

The higher the number of days, the higher the risk resulting from short selling. If, for example, the short interest ratio is 9 days, you should consider whether the shares should be sold short directly and sold back again. The market is extremely volatile in such days.

However, an assessment can be problematic for German traders. Short interest ratios are unfortunately hardly displayed on the German market. However, some short interest ratios from Germany appear every fortnight, by which time it may already be too late for short sellers to react. A good information structure on the ratio is therefore only available on US stock exchanges.