What is Short Squeeze in Crypto?
Introduction
Although they are more frequently linked to the stock market, short squeezes can also happen in the cryptocurrency market. Like stocks, investors who anticipate a decline in the price of cryptocurrencies may short-sell them. Short sellers might have to cover their bets if the price of the cryptocurrency rises abruptly, which might cause a short squeeze. So before we get into how this thing works, let us first understand the concept of short-squeeze in crypto.
What is Short Squeeze in Crypto?
A short squeeze is a one-sided market distortion to sell all available assets. Why do traders and investors trade with such a risky tactic? Let us find out more about the short squeeze and its impact on the cryptocurrency market.
Short squeezes are sudden movements or surges in price on an asset using leverage. This is popularly known as a "short squeeze" because the trader must pay back their purchase price, as well as borrow money to buy the asset, at that moment. If the trader can buy below this price and hold it until the time comes to pay back, he/she would be able to lift the price of his/her asset.
In simple terms, a short squeeze is when a whole bunch of new money comes into a market and drives the price up. This is because new investors think that they will be able to make money if they can sell their coins at a much higher price. This drives up demand and makes it extremely hard for people to buy coins at the current price.
How does a short squeeze occur?
When there is an abrupt surge in buying pressure, a short squeeze occurs. You already know that shorting can be a high-risk technique if you've read our article on it. However, the rapid rush to swiftly cover short positions is what makes a short squeeze a particularly risky event (via buy orders). Numerous stop-loss orders activating at a critical price level and numerous short sellers manually closing their positions simultaneously are examples of this.
Almost any financial market where a short position can be placed is susceptible to a short squeeze. Large price bubbles can even develop when there aren't any ways to short a market. After all, an asset may continue to increase for a considerable amount of time if there is no viable way to gamble against it.
A preponderance of short positions over long positions may be a necessary condition for a short squeeze. Naturally, there is more liquidity available to feed the fire if there are many more short holdings than long positions. For traders who want to monitor market sentiment, the long/short ratio can be a valuable tool. On this page, you can view the long/short ratio for Binance Futures in real-time.
Some experienced traders would search for possible short squeeze chances to go long and profit from the sudden price increase. This plan will involve building up a position ahead of the squeeze and then taking advantage of the sudden rise to sell at a higher price.
Let's use an instance where ABC stock has been trending on the stock market and investors have purchased the stock as a result of its impressive performance and their expectation that it would continue to increase. On the other hand, short sellers, who think that ABC's stock value is only momentarily rising and that it will soon collapse, have also become interested in it.
Short sellers will borrow shares of ABC from their brokerage to start this trade by selling the stock. They will then buy the stock back at a cheaper price and make a profit if all goes according to plan and ABC's stock price declines.
Risks associated with short-squeezing
In the event of a short squeeze, short-sellers run the danger of suffering a substantial financial loss if the stock price increases further. The stock price can still change up or down because there is a sizable short interest that could swing either way. Short interest is a hint that some investors believe the stock price will fall.
Techniques for trading the short squeeze
If you don't pay attention, short squeezes, which can happen quickly and cause the price to spike dramatically, could cost you a lot of money.
If the primary broker, the division of a bank in charge of stock lending, requests the return of the borrowed shares, there can be a rush.
Learn about the short interest ratio (SIR), which is calculated by dividing the number of shares that are short by the stock's average daily trading volume.
Additional buyers are alerted when prices start to change, which amplifies the buying and may cause a stock to go parabolic.
Always apply forceful brakes to your short positions to prevent becoming caught in a short squeeze, especially if you want to hold them overnight.
Bottom line
In conclusion, a short squeeze occurs when short sellers become stuck and are compelled to cover their holdings, which causes a significant price increase.
High-leveraged markets are more susceptible to the volatility of short squeezes. Since cascading liquidations may result in a waterfall effect, price changes also tend to be harsher when more traders and investors use high leverage.
Before you take a short position, be sure you are aware of the consequences of a short squeeze. Otherwise, you can suffer significant losses.
