Business & Investment

Attempting to sell short squeeze stock can be very dangerous.

Investing and trading are two completely different activities. If you’re new to or unfamiliar with how short-selling works, it’s important to understand how this type of high-stakes trading affects stock prices, even if you don’t intend to do it yourself.

Stock shorts are one of the most risky things an investor can do. However, the meme stock frenzy, which essentially plays the other side of short-term trading, can be about as risky as stock prices fluctuate significantly.

First, some definitions. In this article, investing means buying and holding something and expecting it to increase in value, earn income, or both. Transactions are frequently bought and sold to make a profit.

If you buy stock, you risk only the amount you invested. Inventory can be zero and you can lose 100% of the money you invest.

Short-selling a stock is betting that the stock price will fall, and there is no limit to the potential loss if the stock price rises unexpectedly. This does not mean that your potential for loss is unlimited — your broker will limit your loss by demanding more collateral to ensure that you can cover those losses. ..

Mechanism for shorting stocks

Short cell Stock means borrowing a company’s stock, selling it immediately in anticipation of a drop in price, then buying back the stock and returning it to the lender to put the difference in your pocket. This is a special strategy for some professional investors and traders, but it is very risky for individuals and there are multiple reasons.

Some experts benefit from publicly announced bets on companies that feel they are in poor financial condition. Some even claim that the corporate management team has confused investors by inflating their claims about their products and services.

For example, short-selling Hindenburg Research is Nikola Corp.
NKLA,
+ 3.48%

Exaggerating the success of internal efforts to develop battery and fuel cell capacities for electric trucks helped lead to the federal government. Prosecution To its founder, Trevor Milton, and the stock plunged.

The definition of short cell above is simple, but the devil dwells in detail. This follows a few more definitions.

have Long position Being in stock means that you own the stock and expect (or hope) that they will increase in price.

cover It’s time for someone in a short position to buy back the stock, end the short trade and return it to the seller. Shortsellers want to cover and profit after the stock price falls. However, if prices rise, short sellers can also cover to limit losses.

margin The amount the investor (or trader) borrowed from the broker. You can set up a margin account on your broker to basically buy stocks with credit or short stocks. In both cases, the broker sets the limit. If your stock is going down, but you are betting that it will go up instead, you may need to put in more collateral to maintain the agreed margin. Otherwise, the broker will start selling your securities.

This will give you the final definition. A Short squeeze It happens when many investors trying to cover short positions start buying stocks at the same time. The resulting feeding frenzy pushes up stock prices and forces more traders to have short positions to cover. This can happen to any trader. If most of the risk is concentrated in one short position, you can lose your shirt.

It’s best to leave the shorts to an expert

One of the reasons decks are stacked for individual short sellers is that you can’t mitigate the risk by offsetting a large number of short positions with a large number of long positions.

Professional short sellers may have dozens of long positions that offset a large number of short positions, based on their own extensive research. They expect to make some trade mistakes, but the overall risk to professional managers from a single short squeeze is comparable because the risks are diversified and there is a unique trigger on when to cover. It may be small.

Also, if you run out of stock, you run the risk of slow (or fast) bleeding because you wait for enough stock to drop to make the desired profit.For example, at some point in August 2021, the shares of the electric vehicle manufacturer Workhorse Group
WKHS,
+ 3.51%

According to FactSet, 35.81% were sold out.

According to one portfolio manager, it cost 6% a year to borrow a stake in Workhorse from a broker at the time. It may not seem like much, but if the stock went up after a short of 14%, you would pay 20% a year for the privilege of doing high-risk trading.

read: These are the most important things to check on the stock quotes page before deciding whether to buy or sell.

Trying to time short squeeze — memestock boom

Let’s look at short squeeze and real-life examples of short squeeze.Professional traders have shorted shares in video game retailer GameStop
GME,
-0.68%

And cinema operator AMC Entertainment
AMC,
-4.00%

They didn’t think the business had a lot of future. However, some traders posted on Reddit’s WallStreetBets channel saw a surge in both stocks in early 2021 due to a short squeeze described as a class struggle with a hedge fund that shorted stocks. These so-called meme stocks are well above the pre-short squeeze levels.

Short sale to GameStop over 100 Until most of January, according to data provided by FactSet. The short-selling ratio of AMC Entertainment reached 57.81%.

Professionals consider short sales above 30% to 40% to be dangerously high. A high percentage of short squeeze not only makes it very expensive to borrow stock, but also creates a short squeeze hair trigger. And that happened. Both GameStop and AMC Entertainment shares are on roller coasters.

Indeed, squeeze worked for traders entering and exiting at the right time. It wasn’t very neat for others. This chart shows GameStop’s stock price for the first eight months of 2021.

Factset

Since then, the short-selling ratio of both stocks has plummeted, making another short squeeze much less likely. The outlook for both businesses remains poor, especially when compared to the wider stock market. And again, by issuing more shares and raising cash, the two companies can take advantage of new interests among traders and transform their businesses into healthier models.

The bottom line is that shorting individual stocks can be very dangerous. If you reduce this risk by shorting many stocks for a specific reason while offsetting those shorts in long positions and continuously monitoring all positions, there is not much other time-you are a pro Become a trader.

Become a better investor by Subscribe to the MarketWatch Newsletter..

Attempting to sell short squeeze stock can be very dangerous.

http://www.marketwatch.com/news/story.asp?guid=%7B20C05575-04D4-B545-7623-CFEE86A354FC%7D&siteid=rss&rss=1 Attempting to sell short squeeze stock can be very dangerous.

Back to top button