A short squeeze is defined as a situation in which stock, index, commodity, or currency soars, forcing short sellers to exit their positions. How do you identify and profit from a short-term squeeze? Markets are fickle. You never know when your emotions will take control and head in unexpected directions. In the case of trends or even range limits, there are times when prices do not decrease despite the underlying background of a particular security. When everyone is bearish and negative sentiment is exaggerated, a short-term squeeze can lead to price spikes. There are several ways to measure whether a particular player is out. By using a combination of regulated reporting tools and technical analysis, you can quickly determine if the market is offside.
What is a short squeeze?
A short squeeze is defined as a situation in which stock, index, commodity, or currency soars, forcing short sellers to exit their positions. The acceleration in upward pressure has driven irrational sentiment to push prices higher. The term refers to a situation in which a short seller is squeezed out of a short position. When you short an asset, it is often speculated that the price of the asset will fall. If you are short-term regulated securities such as US commodities or stocks, your short position will be reported to the regulator of that market. Short positions in OTC currencies or CFDs are generally not reported. When you short a stock, you need to borrow the stock from someone else who owns it. The goal is to buy back the stock at a lower price and repay the loan you used to borrow the stock.
What started the brief squeeze?
The squeeze could be motivated by fundamentals, the rally being justified, or negative sentiment becoming unsustainable, creating irrational price momentum. A basic driving force could be economic or macro information, you can follow Olymp Trade. Most of the time, those who hold short positions closeout at a loss during the short squeeze.
How do you tell if the market is bearish?
Before the brief squeeze begins, the price starts to rise and you can watch how the market uses a particular instrument. For example, one of the best tools is the Commodity Futures Trading Commission’s Trading Commitment Report. This report is published every Friday unless there is a holiday during the week. The report reflects each investor’s specific holdings by size and occupation of investors. For example, swap dealers manage currencies and retail investors report separately. Swap dealers are investment managers and liquidity providers to commercial entities. Managed money funds and retail investors speak for themselves.
For stocks, short-term interest reports are readily available. All short positions in FINRA member firms can be reported twice a month. The SEC also requires short-term interest reporting. Member companies are considered members of exchanges such as Nasdaq and the New York Stock Exchange. Exchanges generally report short-term interest twice a month. The first time is in the middle of the month and the second time is at the end of the month. The exchange has a mechanism to handle stock splits that occur during the month.
How do you make short-term trades?
When you think market participants are offside and negative sentiment is overdone, your goal is to buy an asset. As mentioned above, you can use tools such as the Trader Commitment Short Interest Report to determine if there is a large short-term interest in a stock or commodity.
CFTC Net Short Position
The table above is an image of the Commitment Trader report for the futures and options portfolio as of November 20, 2018. Each futures contract is reported separately. The soybean contract traded on the Chicago Board of Trade shows that funds under management are in the short-term 132K contract compared to the long-term 72K contract. The number of shorts is almost double the number of long-term hedge funds. This suggests that speculators are somewhat confident that prices will continue to move lower.
The underlying reason for the lower prices is also the Chinese government’s imposition of tariffs on US soybeans to rein in US-initiated tariffs. The trade war these economic powerhouses are going through is driving down soybean prices. Soybeans are piling up in US storage facilities as tariffs and cancellations of orders from Chinese buyers catch farmers off guard. What could change is the agreement between the US and China and the agreement the Chinese government has announced to lift tariffs on soybeans.
Soybean Futures Daily Chart
You can also use technical indicators as a form of confirmation that sentiment has become too bearish. Two good indicators are the Relative Strength Index and the Fast Stochastic. Both of these indicators are momentum oscillators. The RSI measures momentum and oversold/overbought conditions based on the index fluctuating between 1-100. Levels below 30 are considered oversold, and levels above 70 are considered overbought. The Fast Stochastic oscillates between 1-100, with a reading below 20 – considered oversold and a reading above 80 considered overbought.
If you use technical indicators in conjunction with short-term interest rates, such as the Trader Commitment report, you can find specific situations in which funds are running short and the market is oversold. These conditions could lead to a brief squeeze, especially if the fundamental news changes.
Risk and Reward
Generally speaking, in the period before the short squeeze, the price is trending lower. There is a very important trading concept that the market can remain irrational, not that most traders can remain solvent. Just because the market is set for a short squeeze doesn’t ‘t mean the process will work. When you buy a diving knife, you need to exercise reasonable risk management to ensure that you are not driving downtrends the wrong way. You can also establish a position by dipping your toes and making sure you can hold the position if it continues to trade sideways.
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