What is a short squeeze?
The cryptocurrency space has borrowed so much from traditional finance. Among the borrowed phenomenon is short and long trading. With short selling comes a short squeeze. To understand what is a short squeeze, let’s take a step back and look at short selling or shorting.
Shorting is selling a cryptocurrency intending to buy again when the price falls. In the financial world, it’s possible to make money both ways; when the price of an asset is rising or falling. An example of a short position is when a trader sells Bitcoin (BTC) at $11,000 and repurchases it at a Bitcoin price of $9,000, making a profit of $2,000.
Advantages of short selling
Profits can be made in a bear market. Most traders are accustomed to making profits only when the market is bullish. A short position enables traders to benefit even when the prices are going down.
Traders don’t need to own the cryptocurrency being traded. Short selling is powered by margin trading. Here, traders borrow funds from an exchange, open a short position, and pay exchanges after exiting their positions. However, this varies between exchanges since some charge a commission for every four hours the position is open. Trades can be monitored, and losses stopped. Most cryptocurrency exchanges that allow margin trading have features such as stop-loss, minimizing the loss incurred by short-sellers.
The profits can be high, but the risks are equally high. Read more about short positions.
What is a short squeeze?
A short squeeze follows the same route as short selling. The only difference is that instead of the price dropping, it increases. Mostly, short selling falls under margin trading where the trader borrows a cryptocurrency, sells, buys back at a lower price, pays a commission, and keeps the profit. When one is caught up in a short squeeze, they end up making losses.
How does a short squeeze work?
Here’s an example of a short squeeze. A trader borrows funds from the exchange and enters into a short position by buying Bitcoin at $11,000. Unfortunately, instead of the price falling, it increases to $12,000. The time to return the borrowed funds is due and Bitcoin’s price is now at $12,500, with no sign of dropping. This means that you’re in a squeeze; you either buy back at $12,500 or wait to buy later at an even higher price. Instead of a profit, the trader makes a loss of $1,500.
Is a short squeeze predictable?
Yes. However, a trader has to keep their eyes on the interest level. Although this measurement is borrowed from the stock market, it’s incredibly significant in the cryptocurrency market. One way is by checking the number of short positions that have been liquidated before maturity. A higher number indicates that the price is likely to shift from being bearish to bullish, and it’s time to exit a short position.
With the volatility of cryptocurrency prices, a short squeeze cannot be avoided. Therefore, traders in a short position should continue monitoring the interest rate of their asset and predict whether or not they are about to enter into a squeeze. Short selling carries profits and losses in equal measure.