A short squeeze is a financial term often used by investors to describe an abrupt and explosive rally in stock price. Short sellers that previously sold the stock must close or cover their short positions.
A short squeeze tends to feed on itself and can send the price sharply higher as other leveraged short sellers also cover their position. Added buying pressure fueled a further rise in the stock price.
A short squeeze is most likely to develop when the stock has been declining for a while, coming under persistent and fierce selling pressure. Short sellers look to profit from the short-term trade. Convinced the stock will fall more, they dramatically increase their short positions. The selling eventually subsides as buyers slowly return, prompting the sharp reversal.
Better than expected economic news and unexpected earnings can fuel a short squeeze rally. The rally can be days to weeks or months. It depends on various factors, including short interests, days-to-cover, current market conditions, and technical factors. The participants (i.e., technical traders, computerized trading models, momentum investors, and hedge funds) can also influence the duration and the magnitude of the short squeeze.
Traders often monitor various technical indicators to determine if a stock is a candidate for a short squeeze.
The percentage of shares held by short sellers can gauge the potential for a short squeeze. A number far above the norm tends to increase the chance of a short squeeze. Days to cover are also another key indicator. It indicates the number of days it will take for the short sellers to cover their positions. The longer it takes to close the short positions, the higher the chance for a short squeeze situation.
Traders also use technical indicators such as the Relative Strength Index (RSI) to determine overbought or oversold conditions. A stock trading at an oversold level, typically below 20, can trigger a price reversal.
One of the most crucial factors that lead to a short squeeze is when a stock breakout above resistance. A breakout above key initial and intermediate-term resistance can ignite a short squeeze situation.
Attached is a short-term chart of SPY and the levels (resistances) needed to confirm a short squeeze.
Initial resistance is 389-406, coinciding with the top of the March/April 2022 downtrend channel, 50-day ma, Jun/Jul 2022 highs, the 38.2% retracement from the 3/29-6/17/22 decline, and the 38.2% retracement from the 1/4-6/17/22 decline.
Pivotal intermediate-term resistance converges near 422.5-440. The supply zone corresponds to the 61.8% retracement from the 3/29-6/17/22 decline, 1-mo triangle breakout target, 5/4/22 high, 200-day ma, the 61.8% retracement from the 1/4-6/17/22 decline, Jan 2022 downtrend, and large selling versus buying.
A short squeeze occurs on a breakout above initial resistance at 389-406, extending the 6/17/22 oversold rally into late summer. A breakout above 423-440 confirms a major SPY breakout, triggering a significant short squeeze rally toward the 1/4/22 all-time high (476.44).