A long squeeze definitely is a term that may sound foreign to those who haven’t yet been acquainted with it within the capital market world. Nevertheless, this phenomenon brings opportunities on one side and risks on the other depending on how well an investor understands and approaches it.
This is what the article had in store for the reader: what is a long squeeze, what triggers it, and how you can benefit from it. It really shows, as far as possible, the mechanics behind a long squeeze together with strategies that help to gain profits during such market incidents.
What Is a Long Squeeze?
A long squeeze is a situation in which the price of an asset, usually a stock, suddenly drops, and investors who are holding long positions, which means they have bought the asset as an expectation that its price goes up, sell what they have in panic. This is because of a down price movement creating the effect of more and more being forced to sell, sending the price further down.
This refers to the squeeze that the long investors are subjected to as a result of falling prices forcing them to get out to minimize their losses. The difference between the two, however is that in the short squeeze it is the short sellers who have to go for the buy back of their positions to limit their losses, but in the long squeeze, the holders of the long position are trapped in the spiral.
Understanding the Mechanics of a Long Squeeze
For long squeeze mechanics, an easy way to understand how this operates is by the following way:
- A Long Positions: An investor does a long position that gets shares anticipating increased prices for said shares. Then the investor gets to win at such time if the prices go extremely high for that asset but once the prices keep low it then becomes a case for loss accumulation for that investor.
- Margin Calls:Any investor primarily uses margin accounts to open long positions; this is typically when an individual borrows money from the broker to buy more shares than he can afford otherwise. Therefore, if there is a fall in asset price such that the share value drops to a certain predetermined threshold, the investor can be hit by a margin call. They have to put in more funds into the account or sell some of their holdings to raise funds to cover the loan. If the investor is unable to meet the margin call, he might be sold his shares, which would speed up the price fall process.
- Panic Selling: As the price of the asset drops, the long investors will start panicking and sell their positions. News, rumours, or market sentiment that generates fear may enhance this selling pressure with a mass exodus from the asset.
- The Cascade Effect: Now, the more investors get compelled to sell and the price falls further because more long investors sell-off their positions to reduce the loss. Thus, it creates a cycle of self-fulfilment, which may lead to sudden and sharp decline in price.
How to Earn from a Long Squeeze
A painful long squeeze is a blessing in disguise for long stockholders. This gives an opportunity to others in the market. A long squeeze can be used in various ways, such as:
- Short Selling: The clearest way to make money from a long squeeze is through short selling. You would borrow shares of an asset that you would think would decline in value sometime soon and then sell it in the open market. Once it is sold, you then buy back the security for a lower price so you can return it back to the lender and profit from the difference.
Panic selling during a squeeze tends to cause rapid price collapse that can quickly and radically devalue an asset. It is during such times that shorts stand to gain from such selling as they acquire shares at high prices then selling at much lower prices the longer the squeeze lasts. However, short selling comes with all attendant risks, most notably when a rebound takes place. It must be closely watched for any market signal and operated within tight risk management.
- Buy Put Options: One option through which to leverage on the squeeze is buying put options. A put option involves a right, not the obligation, to sell an underlying asset at a price quoted for a certain number of time periods. In fact, it is considered to be a derivative where increases are tied directly with the declines in the values of the underlying asset.
If you believe there is a long squeeze, then you would be making money from the put options buying, in a sense because with the declining price of that asset, the value of those put options would be rising. You sell them so earning. The main benefit with options is that the risk is bounded to the amount of premium a person pays on the options; thus, a long squeeze is potentially one of the more risk-sensitive ways to earn from selling short.
- Hedging long positions: You will be covered if you hold a long position in an asset and are afraid of experiencing a long squeeze, which may cause its price to go through the roof. One hedging strategy that you may adopt is buying put options on the asset or selling futures contracts in it. In these circumstances, your hedging will be making a profit as the asset price falls to absorb part of the loss incurred on the long positions.
Hedging decreases the risk that one faces with regard to the overall profit but also puts a restriction on the gain that can be obtained if the price of the asset increases. This is one strategy that works very well for those who wish to minimize downsides and maintain long positions.
- Long Squeeze through Proper Entry and Exit: This is one other way a long squeeze could work out well in the markets, namely through proper entry and exit points. For a long squeeze generally comes at such breakneck speed that timing has an enormous role to play in this respect. You need to be able to pick up on when a long squeeze starts and be in the market before it drops too significantly. That takes a good feel for market indicators and technical analysis and a keen sense when fear is dominating the market psyche.
You should, therefore know when to leave the trade. Where one leaves the market too early, they risk losing profits, yet where one leaves too late it can mean even worse losses. Use of stop-loss orders and other risk management may help one get through the long squeeze market volatility.
- Watching for changes in market sentiment: Most of the long squeezes result from changes in market sentiment. Bad news or bad earnings lead to long sellers in the equity through a case of panicky selling among investors long of an underlying equity. You can see that whenever there is a likely case of long squeeze.
For example, when you feel that your company is really in trouble, investors have gone nervous, so this can call for a long squeeze. When you feel the mood changes in your favor then you should stop the squeeze, that means you should purchase to join it back.
- Industries and Sectors: Not all industries or sectors are the same in terms of susceptibility to long squeezes. Typically, very volatile industries or those that are very sensitive to market mood are more susceptible to long squeezes. For example, technology stocks or speculative industries like biotech could be more susceptible to high price moves that might end up causing a long squeeze.
Focus on volatile sectors or those that often see sentiment shift quickly. The positioning will be long squeezed when it comes. Notice the sectors and areas that are underperforming or facing headwinds. These could eventually offer opportunities for short sales or other strategies.
- Riding Panic Selling: Panicking selling is highly characteristic in long squeezes wherein investors try to curtail the losses by selling the position. This does become a vicious cycle; it may also be a trading opportunity for contrarians who do not want to short a position. Panicking, which drives the price downwards, undervalues certain assets, which represent buy opportunities for people with the willingness to carry the position for the longer run.
If you can find shares fundamentally strong but temporarily oversold from a long squeeze, then there is a good possibility of picking them up on sale. The chances often come and go in a very short span, so timing and thorough research are very critical.
Risks of a Long Squeeze
A long squeeze isn’t without risk, while it gives investors who understand the dynamics at play access to incredibly lucrative opportunities. The biggest risk that you stand to face is when prices either do not drop as envisioned or rebound suddenly, such that you find yourself having incurred losses. If you are employing short selling or options, you can face unlimited losses on account of the price movement against you.
Besides, it’s difficult to predict when the squeeze will happen because squeezes often get driven by changes in investor sentiment, news, and other external factors. As such, be extremely cautious when trading during a squeeze and have proper risk management strategies in place.
Conclusion
A long squeeze is a phenomenon in the financial markets, which can be difficult and very volatile. If you know how to work with these mechanics and are ready for them, it will help you find a chance to gain profit. For those who like to short sell, buying put options or hedging long positions are ways through which one may take advantage of the long squeeze, but keep in mind that such trading needs proper balance between risk management, market awareness, and technical analysis.
Keep an eye on the market sentiment and time your trade; thus, the pressure of a long squeeze will be turned into an opportunity.
Frequently asked questions
- How does a Long Squeeze work?
A Long Squeeze is the situation whereby, for example, the price of an asset, that may be a stock, begins falling and falls in such a speed that it creates a panic selling condition for the investors who have sold their longs, or bought with a view of selling them at a higher price.
The reason these long investors sell at any cost to curtail losses is because their selling compounds this downward trend and pushes the rest to sell, further creating the reinforcing cycle. The result can be an avalanche effect as forced selling depresses the price in a fast and quick movement, causing long investors further distress. Therefore, effectively speaking, when longs get liquidated, pushing down the price very hard, there exists a so-called “squeeze”.
- How do you take advantage of a short squeeze?
This is known as a short squeeze in the market, where a stock that has substantial quantities of investors shorting it, or betting that it will go down, turns around and starts rising rapidly in price. The shorter start covering their short sale by buying back some, or all, of that borrowed and sold stock. When investors are trying to buy what others are selling, this pressure can be enough to catapult prices even higher.
In a short squeeze, one would buy the stock before squeeze happens expecting short sellers being squeezed out to cover shares and pushes price up. The most important strategies to exploit in a short squeeze are:
- Buy the stock prior to a squeeze: Pick a stock, which has significant short selling and get invested before its squeeze.
- Buying call options: Options that use the leverage potential gain without risking full capital to buy the stock.
- News: Keeping up with news, earnings reports, or other catalysts that might squeeze.
- Who benefits from a short squeeze?
Ordinarily, those at the receiving end of a short squeeze are:
- Long Investors: This investor actually purchased the shares prior to a squeeze and can now sell off because of the increased price based on a short squeeze when short investors buy back shares.
- Option holders: Call option buyers gain in the event that the price of the underlying asset increases; therefore, the latter too benefit from the price rise resulting from the squeeze.
- Market makers: A few market makers or brokers who are allowed to have huge shares of quantities can also exploit this boom in demand and make some money from the price action and liquidity.
- Is short squeeze bullish or bearish?
A short squeeze typically is a bullish event. Yes, the event initially is bearish-many short sellers are betting that the price declines-but during the squeeze itself the price blows higher, because short sellers scramble to buy shares back in to close their positions. That buying pressure pushes up the price and creates a transitory spike in the stock’s momentum.
5.Who loses money in a short squeeze?
Short sellers are the biggest loser of a short squeeze. In such a situation, they have no choice but buy back the stock at ever-higher prices than their selling price when the price begins to rise unexpectedly. This happens to be the time from when they start to incur gigantic losses. Since theoretically an equity can jump to any high value, unlimited losses result when the price keeps rising end.
Other losers in the fray are likely to be the investors who are caught by the price rally without a clear exit mechanism or those who could not appreciate that the squeeze was short-lived.
- Was Tesla a short squeeze?
Yes, numerous times have witnessed short squeezes through Tesla, especially at periods of high acceleration for prices of its stock. In fact, during those years, Tesla earned itself the title of the most shorted stock in the market, and drew in investors who were betting against the company’s growth. The price of the stock, however, went up at various times by a strong earnings report, increased production capacity, and the influence of good market sentiment – forcing short sellers to cover at the expense of the higher currency.
Most of these short squeezes have created grand revivals at different times due to an upsurge in short interest with changing market sentiment and positive company-specific news, which is what directories have been responsible for Tesla’s shares soaring over time.