On January 28, 2021, GameStop Corporation (NYSE: GME) stock rose by over 100% after heavy short interest. The massive buying pressure generated by retail investors caused a “short squeeze”, in which traders who had sold the stock “short” were forced to buy it back at much higher prices to avoid large losses.
This sudden increase in stock price is likely due to the large number of individual investors who trade through online platforms such as Reddit’s WallStreetBets forum. These investors are known for their highly speculative and sometimes risky trading behavior. The GameStop short squeeze is just the latest example of this type of speculative trading activity. In the past, similar events have occurred with other stocks such as Hertz Global Holdings, Inc. (NYSE: HTZ) and AMC Entertainment Holdings, Inc. (NYSE: AMC).
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To “short” a stock, investors borrow shares of the stock from another investor and sell them. They hope to buy the shares back at a lower price so they can return the borrowed shares and keep the difference as profit. However, if the stock price rises instead of falling, short-sellers can be forced to buy the shares back at a much higher price, leading to heavy losses.
The GameStop short squeeze has caused some hedge funds and other professional investors to lose billions of dollars. It also highlights the importance of risk management when investing in stocks. For retail investors, it is important to remember that speculative trading can be very risky and should only be done with money that you can afford to lose.
What is a short squeeze and how does it work?
A short squeeze occurs when the price of a stock rises sharply, causing short sellers to lose money. Short sellers are investors who bet that a stock will fall in value. They do this by borrowing shares of the stock from another investor and selling them, with the hope of buying them back at a lower price and pocketing the difference.
The benefits of a short squeeze for investors
A short squeeze can be a good thing for investors because it can help them make money. If you’re long on a stock that experiences a short squeeze, you can make a lot of money if you hold onto your shares and the price continues to rise.
The risks of a short squeeze for investors
However, there are also risks associated with short squeezes. If you’re short on a stock that experiences a short squeeze, you could lose a lot of money. And even if you’re long on the stock, there’s always the risk that the price will fall back down after the short squeeze occurs.
How to avoid a short squeeze
There are a few things you can do to avoid being caught in a short squeeze. One is to always be aware of the level of short interest in a stock. If there’s high short interest, it means there are more people betting that the stock will fall than rise. This increases the chances of a short squeeze occurring. Another thing you can do is to use stop-loss orders when you buy stocks. A stop-loss order is an order to sell a stock if it falls to a certain price. This can help limit your losses if a short squeeze does occur.