What Is Squeeze and How Does It Work?

UTC by Beatrice Mastropietro · 9 min read
What Is Squeeze and How Does It Work?
Photo: Depositphotos

The term “squeeze” refers to stock price rising in response to short-sellers betting against the stock. It can also refer to spa squeeze when trading volume increases and there are not enough shares available for short-sellers. This guide has all you need to know about the squeeze.

In business, a “squeeze” happens when borrowing becomes difficult or profits decline due to increasing costs or decreasing revenues. In other words, it is a period that is financially challenging because there are more expenses than income for a company.

Businesses can experience squeezes due to economic downturns, market saturation, and increased competition. If a business becomes overextended, it may never recover from the financial stress caused by a squeeze.

There are some simple rules to remember when you may be experiencing a squeeze. Firstly,  when the demand is high, prices will often go up. When the demand is low, prices will often go down.

Secondly, if an item is difficult to produce, it will naturally cost more than one that can be made quickly with few additional costs associated with making it. The reason for this simply being supply and demand are also worth remembering as they become increasingly relevant as things change in any given scenario or situation.

Further, a good way to look at squeeze situations comes from a chess game perspective. Just as in the game, think about where you can put your opponent into checkmate. In other words, what is the final move that will take them out and end the game?

Lastly, remember that nothing is permanent in life and that any squeeze situation you might find yourself in will eventually change. Keep this in mind as you plan your next steps.

Squeeze Definition

The term “squeeze” describes many financial and business situations, typically involving some sort of market pressure. In business, it is a period when borrowing is difficult or when profits decline due to increasing costs or decreasing revenues. When the economy slows down, prices for products often drop because fewer people buy them, which results in less profit for businesses. The opposite can also be true: if more people are buying products, businesses have more customers but need to raise their prices to maintain the same profit level. When this happens, consumers who were happy to pay higher prices may not be willing to do so any longer. This cycle continues until the demand decreases significantly enough to go back to charging lower prices.

For example, consider a grocery store. During the week before Thanksgiving and Christmas, many people head to the store to get their holiday items at once. Stores often stock extra merchandise hoping for this increased demand, but it can be difficult to predict accurately what will happen. If the demand is significantly higher than expected, stores may be left with products that cannot be sold at full price or, in some cases, not at all. Their answer is simple: they lower prices. This squeezes out any additional profit from selling more items. In some cases might even result in a loss if the amount of money saved from dropping prices is less than the cost of maintaining too much inventory.

In the investing world, you may hear the phrase “squeeze plays,” which generally attempt to make huge profits by using borrowed money or investments before they lose value. These squeezes can result in massive profits but also come with significant risks. These riskier investments include margin borrowing and short selling where potential losses can be greater than initial investment amounts.

A squeeze often describes a situation when someone has little room for movement due to external pressures placed on them, such as not having enough money or time to do something they would like. This is most often seen in business situations, but it could involve any situation where one party needs something from another who holds all of the power. For example, two friends might be planning a trip, but one friend’s car breaks down. The other friend might be in a position to cancel the two of them going on the trip or take care of it themselves, causing their friend much stress.

One example in nature is when predators, whether they are sharks at the top of the ocean food chain or an eagle swooping down from above, squeeze prey until they cannot move anymore. This allows for easier eating and digesting for larger animals since their prey has little ability to escape. In business, if you have no choice but to borrow money because your company needs it to survive, you may feel that your company is being squeezed by creditors who have loaned you the money already or whom you must pay back within a specific time frame.

Types of Squeezes

Squeezes are a part of many different markets, from real estate to sports betting. They often involve a high degree of risk and reward. The greater the chance for high returns, the higher the risk that you will lose all your money.

There are different types of squeezes.

  • Profit squeeze. The rise in inflation rates over an extended period is one reason why investors buy gold and silver as hedges against inflation. A profit squeeze occurs when producers increase prices faster than general inflation. This is typically the result of a short supply and/or high demand caused by investors trying to beat inflation. It’s also why gold and silver prices can shoot up so quickly.
  • Short Squeeze. A short squeeze happens when there are more people who want to buy a stock than those who want to sell it, causing its price to rise rapidly as buyers outnumber sellers. This type of situation is possible if traders begin taking profits on their existing holdings, due to some sort of new information that has them thinking the price will continue rising (like good earnings) but at a faster rate than they had initially anticipated.
  • Long Squeeze. A long squeeze is the opposite of a short squeeze and can be caused by many of the same things (a sudden change in sentiment, new information). In a long squeeze, there are more people who want to sell a stock than those who want to buy it, causing its price to fall rapidly as sellers outnumber buyers. One example of this would be when a company announces bad news, like laying off workers, that causes investors to panic and sell their shares, even if they paid too much for them in the first place.
  • Bear Squeeze. A bear squeeze is a situation where all of the traders who are bearish on stock cannot find anyone else who wants to buy. This causes the stock price to rise as buyers outnumber sellers, and those with short positions start feeling pressure to cover them before it’s too late. To do this, they need to buy back some or all of their positions at higher prices than what they sold for originally, thus making money on the difference.

Short Squeeze

A short squeeze is when investors are heavily short-selling an asset. Short-selling is when someone sells something they do not own, hoping to replace it at a lower purchase price.

Short squeezes work by forcing short-sellers to buy back the assets they have sold out of fear that their losses will be magnified if other short-sellers close their positions. Short-sellers do not want others to buy the assets for more than they did, so there is no one left in a position to drive up prices. This can often lead short-sellers into “panic buying.” The price goes up quickly, and the short-seller has little time or capital to get out.

This type of squeeze is often caused by a company or asset experiencing good news and/or positive rumors. This can lead short-sellers to cover their positions, buying back the shares they have sold, which drives the price up even further.

The best way to protect yourself from a short squeeze is to not be short in the first place! Shorting an asset is always risky and can lead to large losses if the market moves against you. If you are long an asset, there is no need to worry about a short squeeze.

Reasons for Short Squeezes

There are many reasons why a short squeeze may happen. Typically, it is when there is an increased demand for a security that has been borrowed and sold short. This can be due to speculation or rumors, or because the security is in high demand and shorts are forced to cover their positions.

Short squeezes can occur at any time but often happen during bull markets. They occur when prices are typically rising, and the shorts are losing money. As the losses mount, they may be forced to cover their positions, which can cause a dramatic increase in the stock price. Short squeezes can also be exacerbated by short-sellers unable to maintain their short positions. Short squeezes are not confined to just stocks but can happen with exchange-traded funds (ETFs) and commodities as well.

Risks of Trading Short Squeezes

The risks associated with trading during a short squeeze are numerous. They include increased price volatility, the potential for a false breakout, and the increased possibility of being squeezed out of a position. When trading during a short squeeze, it is important to be aware of these risks and use proper risk management techniques.

Investors and traders need to be aware of the risks associated with short squeezes when trading in any market. It is important to have a plan going into the trade and take action quickly once a short-squeeze begins.

Examples of Short Squeezes

A prime example of a short squeeze includes the airline industry in 2001 when fuel prices rose steeply. Short squeezes also occur in real estate markets. In a housing market, a short squeeze occurs when many buyers, who have taken out mortgages to purchase property, find it difficult to repay their loans and simultaneously try to sell their properties at the same time. Short squeezes also occur in commodities markets when a commodity producer has difficulty marketing their product, leading to an economic squeeze on producers.

Conclusion

When investors expect a stock to fall, they buy it. This is called “shorting” the company’s shares. When this happens, demand for that company’s stocks goes up, and its price falls as a result. A short squeeze occurs when the stock continues to rise and forces those who sold short (and still hold them) to cover their positions by buying back the shares at an even higher price. In turn, it pushes the price up further, forcing more people with short positions to cover their losses by buying back high-priced shares until there are none left on offer and no one left holding any position shorts whatsoever.

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FAQ

What is a squeeze?

A squeeze is a market situation where the price of a stock, bond, or commodity being sold short has been pushed up into an illiquid trading range, making it difficult to sell short.

How squeezes work?

A squeeze forces short sellers to buy, raising the stock price, which causes them to lose money.

What are the most common types of squeezes?

The most common squeezes are profit squeezes, credit squeezes, short squeezes, and long squeezes.

What is a short squeeze?

A type of price action occurs when a heavily shorted stock or commodity moves sharply higher, forcing more short sellers to close positions and adding upward pressure on the stock.

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