A short squeeze occurs when the price of an asset rapidly rises as a result of numerous short sellers being compelled to exit their positions. Short sellers bet on the price of an asset declining, but if it instead increases, their short positions accumulate unrealized losses. As the price continues to rise, short sellers may be forced to close their positions.
This can happen through stop-loss triggers, liquidations (in the case of margin and futures contracts), or manual position closures by traders seeking to limit further losses. When short sellers close their positions, they must buy the asset, leading to a pronounced price spike. The closure of short positions triggers a cascading effect of buy orders, intensifying the upward pressure. Consequently, a short squeeze is often accompanied by a surge in trading volume.
On the other hand, it is important to note that the larger the short interest, the easier it becomes to trap short sellers and prompt them to close their positions. In other words, a higher level of liquidity available for trapping results in greater volatility during a short squeeze. This dynamic represents a temporary surge in demand coupled with a decrease in supply.
Conversely, a long squeeze, although less common, mirrors a similar effect. It occurs when long holders are trapped by escalating selling pressure, leading to a sharp downward price spike.
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