What Is A Short Squeeze?
Key Takeaways
- A short squeeze happens when many traders who bet against an asset are forced to buy it back at higher prices, pushing the price up even further.
- High short interest, combined with positive news, rising open interest, and oversold technicals, often creates the perfect storm for a short squeeze.
- In crypto, short squeezes are common due to high leverage, volatile sentiment shifts, and the 24/7 nature of trading. Bitcoin has experienced several major squeezes with 17–42% single-day moves.
- Key indicators include short interest percentage, short interest ratio (days to cover), open interest spikes, high funding rates, and long-term downtrends.
- To protect yourself when shorting, use stop-loss orders, avoid overcrowded shorts, and consider hedging with a long position in highly volatile conditions.
- Tools like RSI and Bollinger Bands on platforms like Margex can help spot oversold or low-volatility environments that may precede a short squeeze.
- The Gamestop (GME) short squeeze remains one of the most extreme examples, showing how retail action against institutional shorts can trigger explosive market moves.
- While short squeezes can be profitable, they are highly volatile and often short-lived. Traders should approach them with caution and solid risk management.
What Is A Short Squeeze? Short-Covering Rallies In Crypto Explained
When there is excessively high short interest, the market can move against short positions, forcing short sellers to cover their positions. This combined with an increase in buying pressure can result in a powerful rally called a short squeeze, leading to a surge in share price.
Short squeezes are a fairly common occurrence and can be spotted in advance by analyzing important indicators like open interest, bearish sentiment, and short interest ratio. A short squeeze is often characterized by a large increase in average daily trading volume, which represents both shorts-covering and new buyers entering the market in rapid succession, pushing the stock price higher.
Short sellers don’t always manually cover their positions to contribute to a short squeeze, as they may rely on their broker to facilitate the process. More often than not, the move is strong enough to trigger short-side stop loss orders, forcing traders out of their positions.
| Indicator | Description |
|---|---|
| Short Interest | Percentage of total circulating supply currently held in short positions. |
| Short Interest Ratio | Short positions divided by average daily trading volume; shows days needed to cover. |
| Open Interest | Number of open short positions across all contracts; rising open interest suggests buildup. |
| High Funding Rates | Indicates a crowded short trade; high costs can lead to exits and squeezes. |
| Long Downtrend | Sustained bearish trend may attract shorts and set up for a sharp reversal. |
How Does A Short Squeeze Work? The Mechanics Behind A Short-Selling Showdown
Unlike traditional buy-and-hold investing strategies where investors can only profit when markets are rising, derivatives markets provide a way to profit from both directions of the market, create hedge positions, and be more strategic overall.
Large businesses like energy producers regularly hedge against falling energy prices in this way to stabilize their stock price. Hedging via short positions or options can protect capital and reduce risk. However, like all things in financial markets, short positions do carry risks.
A short position is a type of trading position in the derivatives market where an investor borrows a cryptocurrency from an intermediary and sells it with the intent of purchasing it at a lower price later. A successful short-seller would profit from the difference when the cryptocurrency is later bought back.
Because a short position closing results in a buy order, a large influx of short positions closing at once can push prices of the underlying asset up. When there is heavy short interest in the market, oftentimes a contrarian move will force short sellers out of their positions, causing a short-covering rally that reflects the market dynamics.
Examples Of A Short Squeezes
| Date | Asset | Price Move | Cause |
|---|---|---|---|
| Jan 2021 | GME | +2,000% | Retail buying vs hedge fund shorts |
| Apr 2018 | BTC | +17% | Heavy shorts liquidated |
| Apr 2019 | BTC | +22% | Breakout from downtrend |
| Oct 2019 | BTC | +42% | “Xi pump” from China news |
Perhaps the most famous short squeeze in recent times was the GameStop GME situation in January 2021, which illustrated the risks associated with short selling. Reddit users of the WallStreetBets subreddit often searched for stock shares that were most heavily shorted by hedge funds, and as a community filled with gamers, the consensus took to markets in an attempt to collectively squeeze hedge funds out of their positions. And it worked. GME shares climbed by more than 2,000% in a single month and made a spectacle of markets.
Other important short squeezes have happened all throughout cryptocurrency history. The entire 2017 bull rally in crypto was said to be a heavily shorted rally, as most people expected Bitcoin to correct starting at $5,000 per coin, when it climbed all the way to $20,000. After the eventual peak of that bull market, the next largest short squeeze happened on April 12, 2018, when Bitcoin price climbed 17% in a single day due to an abundance of short positions expecting new lows.
The next massive short squeeze happened on April 2, 2019, when Bitcoin price broke upward out of its downtrend resistance for a 22% move in just one day. Again in late 2019, heavy short interest after Bitcoin broke down from $10,000 resulted in a 42% move within 48 hours as short positions were squeezed rapidly on positive news coming out of China. The cryptocurrency community affectionately called the two-day short squeeze the China pump or Xi pump –– named after the Chinese president Xi Jinping.
Short interest is currently the highest ever in the S&P 500 and across most global assets as investors hedge against a possible recession. However, as the situations have proven above, the current massive increase in short interest while markets are oversold, could lead to a short squeeze setup of epic proportions.
Why Do Short Squeeze Happen? How To Avoid Mistakes When Shorting
| Technique | How It Helps |
|---|---|
| Stop-Loss Orders | Limits losses during rapid upward price moves |
| Hedging with Long Positions | Offsets losses if a short position goes against you |
| Use of Low Leverage | Reduces exposure and chance of liquidation |
| Monitor Open Interest | Identifies buildup of potential squeeze setups |
| Technical Alerts | Early warnings for price thresholds or volatility |
- Always set a stop-loss on short positions
- Don’t short blindly — analyze short interest first
- Check funding rates — high rates mean squeeze risk
- Use hedging longs in volatile markets
- Monitor volume and open interest regularly
Short squeezes can happen for a variety of reasons, but in all scenarios, there must be high short interest and strong bearish sentiment that prompts market participants to believe the price of a cryptocurrency is going lower.
These events trigger at market bottoms, as trend followers and recency bias can cause a large herd of traders to become greedy. Other times, a short squeeze can be caused by a rapid rise triggered by sudden positive news. This can make for a very bad day for short sellers in an instant.
Short interest is highest when investors and traders believe an asset is overvalued and will soon drop in price. While not investment advice, a contrarian investor would look for a long position counter to the dominant short selling side of the trade, anticipating a price rise.
Although there is no way to know a squeeze target, depending on how heavy the short interest is, how high open interest is in general, and how oversold an asset is can lead to an explosive move in the opposite direction. The combination of intense buying and shorts covering results in a large climb in price in a short amount of time.
The most important prevention technique related to reducing the risk associated with short squeezes, to ensure the use of stop loss protection and placement. Without a stop loss, the powerful move can cause short positions to quickly plunge underwater, eating up any available margin and creating a risk of liquidation or margin call in the event of a price rise.
A stop loss will still lead to some incremental loss (unless the stop loss is set to trigger in profit) but it will protect from a maximum drawdown and complete capital loss. Traders can also open a long position counter to a short position to get hedged in case of a reversal.
In this scenario, the stop loss on the short order would trigger, closing it out in a minor loss. Meanwhile, the long position would become profitable, offsetting the incremental loss from the short being stopped out during a ripe for a short squeeze scenario.
How To Prepare For And Find A Short Squeeze About To Happen?
| Indicator | Description |
|---|---|
| Short Interest | Measures the total percentage of assets currently in short positions. |
| Short Interest Ratio | Short positions divided by average daily trading volume. |
| Open Interest | Tracks the total number of open derivative contracts. |
| High Funding Rates | When shorting becomes expensive, it may trigger closures. |
| Long Downtrend | Sustained bearish movement increases short interest. |
Bearish sentiment is a key indicator related to a short squeeze. However, several other important metrics can be measured and analyzed which can tip traders off that a short squeeze is possible. A heavily dominant short-side of the market, combined with soaring open interest, and prices at potential lows are all factors in any short squeeze setup.
Below we will explore the many short indicators that can be used to prepare for a short squeeze effectively.
| Indicator | What it measures | How to interpret it |
|---|---|---|
| Short Interest | % of total supply currently shorted | High = potential short squeeze setup |
| Short Interest Ratio | Shorts / Average daily volume | Shows how many days it would take to cover |
1. Short Interest (% of Supply)
Formula:
(Total Shorts / Circulating Supply) × 100
Why it matters:
High short interest = crowded short trade = more fuel for a squeeze.
Look for values above 20% — that’s the danger zone.
2. Short Interest Ratio (SIR)
Formula:
Short Interest / Average Daily Volume
AKA: “Days to Cover”
If this number is high, it’ll take longer for shorts to unwind → more price pressure.
SIR > 5? You’ve got a time bomb brewing.
3. Open Interest (OI)
What it is:
The number of open derivative contracts (like futures or perpetuals).
Why it matters:
Rising open interest = more positions being opened.
But if paired with high short interest = the squeeze setup is real.
Watch for sharp OI increases during sideways price action — that’s the coiled spring.
4. High Funding Rates
What they mean:
If funding rates go strongly positive (shorts paying longs), it’s expensive to stay short.
What happens next:
Shorts begin closing out. The market reacts like this:
Small bounce → mass liquidations → candle of doom for bears.
Funding rate above 0.10%? Watch your back if you’re short.
5. Long, Exhausted Downtrend
Why this matters:
After weeks of decline, everyone is bearish — and positioned short.
Add in oversold indicators (like RSI < 30), and all it takes is one spark to set off the squeeze.
How To Use Technical Indicators With Margex To Find A Short Squeeze Setup
| Situation | What to do |
|---|---|
| Open interest spikes | Check funding rates and prepare a stop-loss |
| Price nears a major resistance | Avoid adding to short — breakout possible |
| High short interest + positive news | Consider hedging with a long position |
The Margex margin trading platform provides traders with long and short positions and built-in charting tools, In addition to using the external market data listed under short squeeze indicators, many technical analysis indicators can also be used effectively to find signals that help to support a short squeeze setup.
Margex also offers custom crypto price alerts that can be used to be notified when prices pass a certain threshold. When used in conjunction with Margex margin trading tools, traders can be ready for when a short squeeze happens and can react accordingly.
Relative Strength Index
The Relative Strength Index or RSI, is a momentum indicator that helps to measure overbought and oversold conditions. A short squeeze setup would occur for different reasons depending on the readings. For example, a short squeeze is more likely to happen when the RSI shows extreme oversold conditions. However, a short squeeze can also appear when trending assets are overbought and short sellers have stepped in too early, ultimately causing a cascade of stock purchases that help squeeze prices higher.
Bollinger Bands
The Bollinger Bands are a volatility measuring tool based on a simple moving average and an upper and lower band set at two standard deviations of the SMA. When prices are at the upper or lower band, they are high or low in respect to historical price action. This makes any price action at the lower bands a possible place where a short squeeze could occur. If the lower bands were touched multiple times without a breakdown, and the two bands begin to tighten, a short squeeze may result when volatility is ultimately released to the upside instead.
FAQ
How does a short squeeze work?
A short squeeze occurs when a heavily shorted asset suddenly rises in price, forcing short sellers to buy back shares to cover their positions. This buying pressure pushes the price even higher, triggering more forced buybacks—a feedback loop that can lead to rapid price spikes.
Is a short squeeze illegal?
No, a short squeeze is not illegal by itself. It’s a natural market reaction. However, coordinated manipulation to intentionally create a short squeeze (e.g., via pump-and-dump groups) could be considered illegal under market manipulation laws.
What is the biggest short squeeze in history?
The GameStop (GME) short squeeze in January 2021 is one of the most famous and largest in history. Retail investors on Reddit’s r/WallStreetBets drove the price from under $20 to over $480, triggering massive losses for hedge funds shorting the stock.
Is a short squeeze bullish?
Yes, a short squeeze is typically bullish in the short term, as it drives the asset’s price up quickly. However, these moves are often unsustainable and can reverse sharply once the squeeze ends. Traders should be cautious of volatility during such events.
