Why are the short sellers suffering heavy losses in the fierce short-selling market?

Global financial markets are constantly changing, and short selling has gradually shifted from a niche investment strategy to a mainstream topic. However, many short investors often find themselves caught off guard by short squeezes when taking profits, turning from gains to huge losses in an instant. What exactly is going on?

The Essence of a Short Squeeze: The Nightmare of Being Forced to Buy at High Prices

Short Squeeze logic is actually quite simple: when short investors expect a stock to decline and borrow shares to sell short, but the stock price instead rises, these short sellers are forced to buy back shares at higher prices to cover their positions. The faster the stock price rises, the greater the losses for shorts, and ultimately they may be forced to cover due to margin calls—this is the most terrifying aspect of a short squeeze.

There are three main ways to short sell. First, borrowing shares from long-term shareholders and selling them, then buying back after the price drops to return to the original shareholders; second, using futures contracts, paying margin to short without holding physical shares; third, using CFD (Contract for Difference) contracts, which also operate on margin but do not require transferring ownership. Regardless of the method, if the stock price continues to rise, there is a risk of margin calls due to insufficient collateral.

How Does a Short Squeeze Form? Two Major Triggers

GME Event: Retail Investors Team Up Against Wall Street

In September 2020, Canadian entrepreneur Ryan Cohen made a major move into the board of the game retailer GME, driving the stock price from single digits to nearly $20. However, many Wall Street institutions quickly issued reports claiming GME was severely overvalued and began shorting the stock. The short interest even reached 140% of the circulating shares—more than all tradable shares in the market.

This news exploded on the US Reddit forum WSB. Driven by nostalgia and enthusiasm, hundreds of thousands of retail investors teamed up to buy GME. On January 13, 2021, the stock surged 50% to $30, and within two weeks, on January 28, the price soared to $483. Short sellers, due to margin shortages, were forced to cover at a huge loss—media reports indicated losses exceeding $5 billion. After the short squeeze ended, the stock price plummeted over 80% from its peak.

This event shook the global financial markets. Subsequently, WSB members also promoted stocks like AMC and BlackBerry, which had high short interest, leading to rapid rises and quick crashes in short order.

Tesla: Fundamentals Improve Naturally Triggering a Short Squeeze

Unlike the human-driven manipulation of GME, Tesla’s short squeeze was driven by genuine fundamental improvements. For years, Tesla, despite being a leader in electric vehicles, suffered losses due to modest sales, making it one of the stocks with the highest short interest.

Until turning profitable in 2020, with revenue from the Shanghai Gigafactory, Tesla’s stock price began to skyrocket. In just half a year, it rose from $350 to $2,318. After a stock split, the price again surged from over $400 to over $1,000 within a year. Over two years, the stock appreciated nearly 20 times, causing enormous losses for short investors.

Tesla’s rise was also supported by the global QE environment following the COVID-19 pandemic, but this remains a classic example of a fundamental-driven short squeeze.

How to Handle a Short Squeeze? Two Self-Help Strategies

First: Cut Losses and Exit Early

If short interest exceeds 50% of the circulating shares, even if the stock remains weak, it’s wise to cover early. At this point, observe the RSI indicator—when RSI is between 50 and 80, bullish momentum is stronger than bearish; when RSI drops below 20, it indicates an oversold condition, and the market is no longer rational, increasing the likelihood of a reversal. For short sellers, this is a warning to stop losses promptly. Small profits or small losses are acceptable; surviving is the priority.

Second: Follow the Change in Market Sentiment

If you want to ride the wave of a short squeeze, closely monitor short interest changes. As long as short interest continues to increase, you can follow; but once signs of short covering appear, you should immediately take profits and exit. These buy orders are not based on confidence in the company’s prospects but are forced repurchases by short sellers who have driven the stock price higher—once the squeeze ends, the stock will rapidly fall back to a reasonable level.

How to Prevent Short Squeeze Risks? Three Recommendations

A short squeeze typically requires two conditions: excessively high short interest and extremely high market attention. Therefore, when choosing stocks to short, investors should prioritize major indices or blue-chip stocks, as they have high liquidity and are less likely to experience dangerous high short interest positions.

In a bearish market, it’s better to wait for a rebound before shorting, rather than rushing in blindly. Additionally, adopting a hedging strategy is advisable: buy fundamentally strong stocks to go long, while shorting the market index. If the ratio is 1:1, when the stock outperforms the index or declines less than the index, investors can profit and effectively balance risk.

Survival Rules in a Short Squeeze

Short selling is essentially like robbing a bank—regardless of success, a safe exit is crucial. The maximum profit for shorts is when the stock price drops to zero, but they face the nightmare of the stock soaring multiple times or even dozens of times in a short period. This makes short selling a “limited profit, unlimited risk” investment approach.

In environments with frequent black swan events like the Fed’s rate hikes and balance sheet reduction in 2022, the Russia-Ukraine war, China’s lockdowns, and US-China tech battles, short squeezes are still everywhere. Investors should remember: besides monitoring market movements, paying close attention to stock fundamentals and news is essential. A single positive news can ruin a carefully crafted short strategy. In the face of a short squeeze, the ability to cut losses promptly is often more valuable than trying to squeeze out the last bit of profit.