Shorting stocks is a well-known and popular way to make money in the investment landscape. With the right strategy, you can make profits and build a great portfolio based on nothing but speculation. You don’t have to actually buy the stocks you want to trade to take advantage. Instead, you can just borrow them from the broker you’re working with. However, this does mean that you will need to eventually buy back and give back what you owe.
The idea of shorting is that you sell the security when it’s worth a lot, with the assumption that you’re going to see a significant drop in the price later. This should mean that you purchase what you owe again and make a profit on the difference between the price you got for the stock, and the price you paid. It’s an exciting part of the stock and securities landscape. Short squeezing, however, is one example of how this strategy can go wrong.
Understanding Short Squeezes
When a short squeeze happens, this means that the company has been successful in a marketing or sales campaign which brings in new buyers. Suddenly the value of the company goes up, and the securities are now much more expensive than they were before. The cost of the shares can skyrocket by hundreds, or even thousands overnight.
When a squeeze happens, the short traders need to get out as soon as possible. Though some squeezes have proven to be temporary in the past, short sellers can’t take the risk that they won’t be able to afford to buy back what they owe at a later time. Most jump to get out of their position as fast as they can, so they can limit their losses. Although there is no way to fully predict and prevent squeezes when you are building your financial portfolio, there are steps that some groups and individuals can take to improve their trading strategy when short selling.
For instance, tactics like looking at the short interest percentage can be quite useful. In most cases, the higher the percentage is, the higher the number of short sellers there will be competing against each other to purchase the item back if the price rises. It’s also worth looking at the short interest ratio, which is the interest divided by the daily trading volume for the security in question. The higher the ratio is, the more likely it is that short sales professionals will continue to drive the price up.
Being Prepared for Better Trading
All kinds of investment and trading strategy come with their own pros and cons to consider. There are risks in anything you choose to place your money into. However, most experts agree that learning how to properly understand your marketplace and making the most of the tactics available to you can save you a lot of time and effort. Although tactics like short selling can be effective when you get the timing right, it’s important to make sure that you consider your options carefully, and have the right strategy before you jump in. Don’t underestimate the risk of falling victim to a squeeze.