What is a short squeeze?

Key points

• A short squeeze is a surge in an asset’s price triggered by a heavy build-up of short positions; closing those shorts requires buying, which adds demand and drives the price higher still.
• Short squeezes feature rapid price increases, elevated trading volumes and high volatility—often inflicting heavy losses on short sellers.
• To curb the risk of being caught in a squeeze, use stop orders and hedging tools, and keep leverage low.

What is a short position

Before discussing a short squeeze, it helps to define a short position. When opening a short, a trader borrows an asset from a broker or exchange, posting their own funds as collateral. The position is closed by buying back the same quantity of the asset at the prevailing price. Profit arises if the asset’s price falls.

For example, a trader opens a short for 1 BTC at $30,000 per coin. After a while the bitcoin price falls to $25,000, and the trader buys back the borrowed asset. The difference between the selling and repurchase prices—$5,000—is the profit.

If the asset’s price rises after the short is opened, the position incurs losses. If the trader lacks sufficient funds to cover them, a margin call ensues, which can lead to forced closure (liquidation) of the position.

How a short squeeze forms

One key cause is a dense cluster of open shorts at a given price level. As quotes move higher, traders are forced to manage risk and close losing positions.

Because closing a short requires buying the asset, rising prices only increase demand. That in turn propels the price further up, deepens losses for short holders and can produce mass liquidations.

The automated nature of modern trading, bouts of panic and heavy volumes can produce outsized spikes—sometimes tens of percent. In some cases, a squeeze can even trigger trading halts.

A similar episode occurred on Nasdaq with shares of Robinhood Market—volatility forced three trading halts.

Examples

Short squeezes occur across markets, including crypto. Two examples follow.

GameStop

In November 2020 members of the WallStreetBets subreddit spotted short positions held by the hedge fund Melvin Capital in the shares of GameStop (GME), a retailer then near insolvency.

Online “activists” decided to exploit the discovery, piling into GME on the exchange to keep the company from collapse. The effort went viral; in under a month GameStop’s shares rose more than 20-fold.

According to calculations by the Wall Street Journal, the squeeze wiped out 30% of Melvin Capital’s capital, and aggregate losses for GME short sellers reached $19.75bn.

Celsius Network

In June 2022 the crypto lending platform Celsius froze withdrawals, swaps and transfers between accounts due to extreme market conditions. The move sent its CEL token sharply lower.

A group of enthusiasts used Twitter to attempt a GameStop-style squeeze, rallying around the hashtag #CELShortSqueeze.

According to Decrypt, the key argument for a squeeze was Celsius’s halt of withdrawals, including CEL tokens. On top of that, the firm’s financial troubles were expected to attract short interest from traders and larger players.

The plan was to buy CEL on exchanges and move it to cold wallets so no one could use those tokens to sell. As a result, between 19-21 June 2022 CEL nearly tripled—from $0.55 to $1.50.

How to protect yourself from a short squeeze

Squeezes are common in crypto, given the thin liquidity of many assets, limited hedging tools and weak legal frameworks. To mitigate the risk, consider:

• Stop order. The simplest and most effective tool. It shields an open short from full liquidation and helps avoid emotional decisions.

• Hedging. When opening a short, hedge it with an offsetting trade: if you are short, open a long on the same asset. If prices move against you, the hedge helps reduce losses.

• Spot trading. Spot markets avoid any debtor–creditor relationship between trader and platform—eliminating liquidation risk. Spot trades are not designed to profit from falling prices, but they remove many risks, especially for beginners.

• Low leverage. Traders often use high leverage, which multiplies the risk of financial loss. According to Binance, in 2019 some 60% of futures positions were opened with 20x leverage, a high ratio. As Morgan Creek founder Mark Yusko said, leverage “never makes bad investments good, but often leads to good investments becoming bad”.

Further reading

How does the Fed’s rate affect the price of bitcoin?

What is crypto arbitrage?

Where to track cryptocurrency prices?

What is the MVRV indicator?

What is a moving average and how is it used for crypto?