A short squeeze is a phenomenon that often results in a rapid increase in the price of an asset in financial markets. Let's see how it works.
What is a short position?
A short position is when a trader sells a borrowed asset, expecting its price to fall. Once the price drops, the trader buys the asset back at a lower price, returns it, and locks in the profit on the difference. However, if the price starts to rise instead, the short seller's losses can be unlimited.
What is short liquidation?
When the price of an asset starts to rise, traders who held short positions face losses. If the price rises high enough, brokers or exchanges may force these positions to close out their risks. This is called liquidation. In such cases, a trader is forced to buy the asset back at a higher price to close their position.
How do short liquidations affect price growth?
1. Bulk Buying: When short positions are liquidated, traders are forced to buy the asset at the current market price to cover their losses. This increases demand for the asset, which leads to a further increase in price.
2. Chain Reaction: If there are many liquidations, it can trigger a chain reaction. With each new liquidation, demand increases, which pushes the price up even more. This effect is known as a “short squeeze” – a sharp and continuous increase in price caused by forced buying of assets.
3. Panic among short sellers: Traders who see that the price continues to rise may start to cover their short positions en masse early to avoid even greater losses. This creates additional pressure on the market, and the price may jump even higher.
Conclusion: Short liquidations can be a powerful catalyst for price increases. When short positions are covered en masse, it creates a lot of demand for the asset, which pushes the price even higher.
