10 Signs of an Upcoming Short Squeeze

Disclaimer: This post does not constitute financial advice. Do your own due diligence before making an investment.

There’s a lot of money to be made in a short squeeze, but if you have to time it right.

Here are 10 signs that a short squeeze might be imminent.

1. Your Stock is Trading Near 52-Week Lows

Generally speaking, good companies shouldn’t do this. Especially if the indexes are trading near all-time highs. Almost every stock is part of an index. Either a total stock market fund or a specialty fund. As money flows into these funds, managers buy stocks.

In a news vacuum, if people buy stocks, then stock prices go up. This is basic economics. If supply goes down and demand goes up, then prices almost always go up.

So, if your stock is trading at 52-week lows, then you need to investigate why. If the answer is, “Because of stock manipulation,” then you could be looking at an upcoming short squeeze.

All stocks have a “fair value” price which is a factor of their assets, liabilities, and future prospects. If you suspect this is out of alignment, then you must figure out the fair value. That’s your minimum target squeeze price.

The thing about markets is that prices always swing too far. When prices drop, they always drop too much. When prices go up, they always go up too much. This can be attributed to hysteria, panic buying, and panic selling. Eventually the momentum eases and prices settle back to their fair value. It might take a while, but prices always settle.

In the long run, it’s impossible for a great company to trade significantly below its fair value. If it has dropped too much, then the snap back to reality can be vicious.

2. High Short Volume, High Short Interest

How high is the short interest in your stock? Is it over 20%? Because that’s around when you should start paying attention.

Some stocks have a higher short interest. Maybe even 30%, or 40%. The higher the short interest, the more vulnerable a stock is to a sudden short squeeze. Remember, the pendulum always swings too far.

As stocks keep dropping, sentiment keeps getting worse. Eventually the shorting of a stock is seen as “free money” by inexperienced investors. That’s a major indicator that you’re near the bottom. Nothing is guaranteed in life. If everyone is saying company is going to zero, but based on your research you disagree, then it might be time to load up.

3. Borrowing Costs Keep Getting Higher

When you short a stock, you must first borrow it from someone else. To do this, you’ll have to pay interest. This cost is influenced by the availability of shares to short.

Borrowing costs are updated frequently. Maybe even to the second with your broker. Whereas short interest is only updated twice a month. So, borrowing costs are something to keep an eye on.

If borrowing costs are getting high, this might mean you’ve reached the bottom. If there are no more shares to short, then the only way the price can drop is if a large amount of stock is dumped onto the market, either by a holder, or the company (as in they do an offering).

4. Sudden Drop in Borrowing Costs

Yes, we just said that high borrowing costs can be seen as an indicator of a short squeeze. But lower borrowing costs can as well.

It depends on the timing. If borrowing costs drop 30% on Monday on strong volume, and a large uptick in stock price, this could mean someone with a large short position has started to cover.

Covering a heavily shorted stock is a like a game of musical chairs. Short sellers must find a chair before the price of the stock goes past their entry point. This can create a stampede. The stampede is what powers the short squeeze. If short sellers have miscalculated the strength of share demand, or quality of the company, then finding a chair can become quite pricey. As seen in the GameStop short squeeze, the price of $GME in January 2021 went from $17 to $480.

5. Strange Behavior of ITM Call Options

If you’re closely following a stock because you’re expecting a short squeeze, then you must absolutely follow the options market.

Here’s the thing about options, most small traders only buy calls or put options. Their risk is limited to their investment. If they buy $10,000 in short-term calls, and the stock plummets, they only lose $10,000.

On the other side of that trade is the person who sold them the calls. Now this is where it gets interesting. This person/fund might not have owned the underlying asset to begin with. This means instead of a covered call, it would have been a naked call.

Hedge funds and large banks write naked calls all the time. Naked calls are dangerous for small traders, but relatively safe for the big fish. This is because they have the firepower to control the stock price.

It’s completely legal for a large bank or fund to sell a ton of naked calls, and then destroy the share price by shorting the stock to death. It shouldn’t be legal, but it is. This is like selling someone tokens that can be placed in a slot machine, and then unplugging the slot machine. The chance of winning is zero. Wall Street gets away with it because it’s not as obvious as unplugging a slot machine. It’s just a slow bleed for a few weeks until the options expire worthless.

Here's a scenario you’ve probably seen before. A company releases great news on Wednesday, Thursday, or Friday morning. The stock initially pops 5-20%, but then settles down flat, or even red. Friday at 4pm most of the call options expire worthless. And then on Monday…the stock starts climbing again.

This isn’t just bad luck. Wall Street did that on purpose to protect their naked call positions.

So, what does all this have to do with a short squeeze?

Options can be sold for later dates. Months or years in advance. Wall Street sells naked calls planning to keep a lid on the price. But then something might change. A new development occurs. An analyst calls up the trading desk and say something like, “There’s a strong possibility that the government is going to introduce huge subsidies this Friday for solar-powered lawnmowers, so we recommend going long on the Super Solar Lawn Company.”

“What the hell?” says Fat Bob the solar trader. “You told us solar-powered lawn mowers were garbage. We’re heavily short.”

“Then we recommend you close your short position,” says the analyst.

“THANKS FOR THE HEADS UP,” yells Fat Bob. “IT’S ALREADY WEDNESDAY!”

Now what happens is Fat Bob needs to close his naked call position. The way he does this is by hammering the stock a few points, and then buying back the same calls he sold.

So, you need to keep an eye on the open interest. If there are 20,000 calls options expiring on Friday, and the stock drops a few points, and suddenly there’s heavy call volume, then check back tomorrow. If the open interest dropped from 20,000 to 12,000, then someone closed a large position.

Be careful here unless you know for sure what’s going on behind the scenes. Fat Bob might have been long. He might have closed his position because he expects the stock to tank by Friday.

Keep your eyes peeled. Unusual options volume does not manifest in a vacuum.

Someone is making a play.

6. Upcoming Major Catalyst

Short squeezes are often triggered by catalysts. News events, major developments, product approvals, breakthroughs, etc. Does your stock have one of these coming up?

When your Annual General Meeting? What’s on the ballot? Has a large shareholder put forth a proposal that would significantly change the company?

If you’re hoping for a short squeeze, then there needs to be a catalyst. People don’t start madly buying stocks for no reason.

If you’re betting on a short squeeze, you must be aware of everything that’s coming up soon for your company. Each catalyst has a probability that might send your stock to the Moon. Know these probabilities and trade accordingly.

7. Stock is Trading at a Huge Discount to Competitors

Imagine you run a lemonade stand. You sell between 20-30 cups of lemonade per day. Wall Street says your business is worth $10,000 dollars. They offer you a buyout of $15,000, which you decline.

Your neighbor also has a lemonade stand. They sell a similar number of cups per day. But Wall Street says this lemonade stand is worth $25,000.

This is a large disconnect in the price. When you ask why your neighbor’s lemonade stand is worth more, Wall Street makes up some excuses like, “We don’t like the color of your cups.”

Or, “Their management team is better.”

But it’s a lemonade stand. It can be run by an idiot. And your market research has determined that customers don’t care about the color of your cups. And since you buy your lemons from the same grocery store as your neighbor, the product is nearly identical.

This happens with companies all the time. But it’s less obvious because billion-dollar companies are more complicated than lemonade stands.

8. Overwhelming Sense that Something Fishy is Going On

If you follow a particular stock very closely, then you know what I’m talking about. Bizarre price movement becomes extremely obvious if you’ve got your eyes glued to the chart every day.

Is your stock always red? Are the message boards invested with trolls and low-quality posters? Does your stock always drop on good news?

These are all indicators that it’s being manipulated lower. The lower a stock a drops, the higher it bounces during a short squeeze.

Mania can occur on both sides of a trade. If people see a stock is always red, they might start to believe it’s going to zero. Humans are great at spotting patterns. They see it dropping every day and expect it to continue doing so. So, they expand their short position and open themselves up to unnecessary risk.

This is where the bears get massacred.

9. Shares Available to Short Approaches Zero

Every stock has a finite number of shares. Some of these shares cannot be loaned because the owner has instructed their broker to not allow borrowing. The owner might have also set a limit sell price that’s higher than the current price, which removes the shares from the borrowing pool.

As a stock drops, more short-sellers pile into it. It begins to be seen as a great trade.

“Shorting this company is free money,” people will say. That’s usually a good indicator that the bottom is in.

To verify that shares to borrow are unavailable or running low, you can either test it yourself, or ask around. Try to open a short position with the stock. If your broker isn’t allowing it, ask them why. If they tell you there aren’t any shares available to borrow, then you might be near the bottom.

This can be seen as indicator that the pendulum has swung too far. If the sellers can’t short any more shares, then they have to rely on whales dumping their position for any further major price drops. (Or an at-the-market offering from the company.)

If you believe it’s unlikely that institutional investors/large stakeholders will dump shares at this price, and you think dilution is off the table, then the price could be bottoming out. This doesn’t mean a short squeeze is inevitable, but it greatly increases the chance of one.

10. Institutional Investors are Loading Up

This is my favorite indicator that a short squeeze might be near.

You can use a variety of different websites to check this, or you could look through the 13-F filings of large institutions.

If the stock price is at an all-time low, and you check the 13-F filings and see that Morgan Stanley increased their position by 2,947,392 shares last quarter, that’s a great sign.

Large institutions have billions, or even trillions of dollars of assets under management. They have all the patience in the world. When you were buying at $10, they were shorting. When you were borrowing to buy at $4, they were shorting. When you got flushed out $2, that’s when they started buying.

Institutions often wait for rock-bottom prices before loading up.

If you’re looking at a stock and thinking, “Oh my god, I can’t believe it’s this low, this doesn’t make any sense,” you could be near the bottom. The closer you are to the bottom, the more likely a short squeeze is, especially if institutions have been buying.

Once Wall Street has bought all the stock they want, there is less incentive to manipulate the price. It’s like a stretched out elastic band that snaps back in the other direction.

Know Your Exit Point

At some point you have to sell. It’s foolish to hold on to a stock that’s being squeezed because all short squeezes are temporary. This is because the top will always exceed the fair value. If a stock exceeds its fair value by a wide margin, then people begin to sell. This selling allows the shorts to cover, and/or start shorting again.

Know your exit price and stick with it. It can be tempting to hold as your stock is mooning because it looks like it’ll just keep going, but it won’t. It never does. Price always settle.

It is unlikely you time this perfectly. Be happy with your gains and stop watching the stock. If it climbs any higher, it’ll just depress you and make you feel dumb.

But you are not dumb. Taking monster profits in a short squeeze is never dumb.

Check back in a month and you’ll probably be thrilled. By then the price will have settled far below the peak. It always does.

Good luck with your investments, and don’t forget to follow us on Twitter for additional in-depth analysis!