"One's man loss is another man's gain". This proverb explains the beauty of the stock market where investors can gain from either a rising or falling stock due to something called short selling. Short selling refers to the trading strategy of borrowing a stock whose price is expected to fall, selling it in the open market, then repurchasing It at a lower price than what was initially borrowed for. The trader gains from the difference between the selling and repurchase price. However, surprises are inevitable, and a short squeeze may occur, which means an unexpectedly sharp increase in heavily shorted stock, forcing short sellers to cover their positions by buying back shares. This unexpected increase in demand may set off a cycle that raises the stock price even further, resulting in sizable losses for those who bet against it.
There have been a number of major short squeezes throughout history. Let's examine some of the most memorable examples in more detail.
- Silver (1980):
While usually short squeezes occur for stocks, they can occasionally affect the commodity markets. In 1980, the Hunt brothers, Nelson Bunker and William Herbert, accumulated a large quantity of silver trying to corner the market, aiming to gain from their long positions. However, this led to a short squeeze as traders rushed to cover their positions amid fears of the bubble to burst. Silver prices skyrocketed from less than $10 per ounce to $48.70 before eventually collapsing.
- Volkswagen (2008):
Another notable short squeeze is Volkswagen stock. The squeeze was driven by Porsche increasing its share in the company without publicly disclosing its acquisition intention in 2005. Short sellers then faced a shortage in the freely tradeable shares of the stock (less than 6%) as most of the shares were either owned by Porsche or the German government. This shortage caused the price to shoot up, becoming a target for short sellers, since prices were expected to fall due to the challenging economic environment of the financial crisis.
Short sellers were forced to repurchase a large percentage of VW shares that they had borrowed and shorted. With the limited number of shares available, they scrambled to buy the remaining shares, causing the stock price to skyrocket from €210 to €1,005 in just two days. This short squeeze led to short-sellers purchasing the stock at increasingly higher prices in order to cover their short positions. As a result, Volkswagen's market capitalization surged to $370B in just two days, becoming the world's most valuable company. To control the squeeze, Porsche then revealed its plan to sell up to 5% of its stake in Volkswagen at a profitable margin which immediately caused Volkswagen's stock to decline by approximately 37% to €596 on October 29th, compared to the previous day's closing price of €945. Over the following weeks, the stock continued to decline, reaching a 70% fall from its peak.
- Tesla (2020):
Tesla (TSLA) has experienced its fair share of short squeezes over the years. In 2020, as Tesla's stock price soared driven by high demand, short sellers found themselves in a worrisome position. Losses amounted to $38B throughout 2020 including a $2.5B loss in only one day. Short interest in the shares fell to less than 6% of Tesla's float from nearly 20% as the company's rally led investors to close their positions.
- GameStop (2021):
The last short squeeze on our list is the recent GameStop short squeeze. A group of retail investors on Reddit's WallStreetBets forum noticed that hedge funds had heavily shorted GameStop stock, so they bought the stock en masse causing the price to shoot up from around $20 per share to over $400 within weeks. This was a move against the short selling hedge funds whom took on losses of billions of dollars, even causing some to shut down completely.
Overall, a short squeeze is a compelling phenomenon that can have widespread effects on both individual investors and the overall financial markets. While they can lead to substantial profits for those who make the right moves, they also heighten the risk associated with short selling and market speculation. Therefore, investors and traders should be careful. The past has demonstrated repeatedly that such events can be unpredictable and carry significant ramifications for all parties involved.
The content published above has been prepared by CFI for informational purposes only and should not be considered as investment advice. Any view expressed does not constitute a personal recommendation or solicitation to buy or sell. The information provided does not have regard to the specific investment objectives, financial situation, and needs of any specific person who may receive it, and is not held out as independent investment research and may have been acted upon by persons connected with CFI. Market data is derived from independent sources believed to be reliable, however, CFI makes no guarantee of its accuracy or completeness, and accepts no responsibility for any consequence of its use by recipients.