One of these phenomena, the "short squeeze," has the power to dramatically increase a stock's price over night. So, what is "short squeeze" in crypto?
What is "short squeeze" in crypto?
A short squeeze happens when the price of an asset sharply increases due to a lot of short sellers being forced out of their positions.
Short sellers bet on the drop in value of an asset. In the case that the price increases, short positions begin to accumulate an unrealized loss. As the price goes up, short sellers may be forced to close their positions. Stop-loss triggers and liquidations are two ways for this to happen (for margin and futures contracts). Additionally, it may occur when traders manually close their positions in an effort to prevent suffering greater losses.
So, how do short sellers close their positions?
They spend. This is the reason why a short squeeze causes a sudden increase in price. A cascading effect of buy orders adds more fuel to the fire as short sellers close out their positions. As a result, a short squeeze usually results in an equal increase in trading volume.
Short squeeze examples
In the cryptocurrency markets, most notably in the Bitcoin markets, short squeezes are also pretty common. High-leverage positions are used in the Bitcoin derivatives market, and these can be trapped or liquidated with only little price changes. As a result, there are frequently short- and long-squeeze cases in the Bitcoin markets. Think cautious about how much leverage you're using if you don't want to get trapped in such moves or liquidated. You should also adopt a proper risk management strategy.
Look at the Bitcoin price range from the beginning of 2019. The price was contained in a range after a sharp move to the downside. Since many investors would be looking for short positions and expecting the downtrend to continue, market sentiment was probably fairly low.
Price flew through the range, though, so quickly that it wasn't even tested again for a while. It only got a retest years later, during the coronavirus pandemic (also known as “Black Thursday”). This rapid move was probably caused by extensive short covering.
Closing thoughts
In conclusion, a short squeeze occurs when short sellers become trapped and are forced to cover their positions, which creates a huge increase in price.
High-leveraged markets are more vulnerable to the volatility of short squeezes. Since cascading liquidations may result in a waterfall effect, price moves also tend to be sharper when more traders and investors use high leverage.
Make sure you understand the implications of a short squeeze before you enter a short position. Otherwise, you could suffer huge losses.
