Short-selling trap: Understanding the true meaning of short squeeze and how to respond

There are always two types of players in the investment market—bulls who are optimistic and bears who are pessimistic. Many believe that short selling is a quick way to get rich, but they fail to realize that this path is full of traps, the most dangerous of which is a short squeeze. To survive longer in a bear market, you must first thoroughly understand the true meaning of a short squeeze.

The Real Meaning of Short Squeeze: It’s Not Just Price Increase

A short squeeze (Short Squeeze) is simple to understand: when the price of a stock or asset rises rapidly, short investors are forced to buy back the asset at high prices to cover their positions, which further drives up the price, creating a vicious cycle.

This concept seems easy to grasp, but the market logic behind it is much more complex. A short squeeze is not just a price increase; it is a psychological battle between short investors and long investors.

First, clarify the three main ways to short:

First: Borrow stocks to short sell
Borrow stocks from long-term shareholders, pay interest, and sell them. When the stock price falls, buy back and return to the original shareholders. This method seems simple, but once the price rises, investors face the risk of forced covering.

Second and third: Futures and CFD contracts
Operate short positions through margin trading. Although no physical stocks are borrowed, they face the same risk of margin calls when prices rise.

The Power of Short Squeeze Seen in the GME Event

At the end of 2020, US game retailer GME was heavily shorted by Wall Street due to poor fundamentals. At that time, short positions even exceeded GME’s total shares outstanding, reaching an astonishing 140%.

The turning point came in September 2020, when Canadian entrepreneur Ryan Cohen made a large investment and joined the board, triggering a market re-evaluation. But Wall Street’s shorting institutions did not buy into it; instead, they increased their short bets, believing this “overhyped” gaming company would eventually return to lower levels.

No one expected that the Reddit community on the WSB forum would turn this into a “retail investors vs. Wall Street” battle. These users called for buying GME, and within two weeks, the stock price soared from $30 to $483. Short investors, due to margin calls, were forced to cover at sky-high prices, with media estimating losses exceeding $5 billion.

This event perfectly illustrates the true meaning of a short squeeze—it’s not just about price increases, but about short investors being trapped, forced, and ultimately forced out.

Tesla’s Fundamental-Driven Short Squeeze Case

If GME was artificially manufactured, Tesla’s short squeeze was a natural result of improving fundamentals.

Tesla was once a “disaster zone” for Wall Street shorts, due to continuous losses in early years, with skeptics doubting its prospects. But under Elon Musk’s leadership, the company turned profitable in 2020, with explosive growth from the Shanghai Gigafactory. In just half a year, the stock price rose from $350 to $2,318, and after a stock split, it continued upward, eventually surpassing $1,000.

In two years, the stock price increased nearly 20 times, demonstrating the power of a short squeeze. The losses for short sellers were so severe that they serve as a warning to any investor.

Pre-Indicators of a Short Squeeze

Not all stocks are prone to short squeezes. The following conditions typically indicate higher risk:

High short interest — Short positions exceeding 50% of the circulating shares
Low liquidity — Small market cap, low trading volume, easy to manipulate
High market attention — High media coverage attracting speculative capital
Presence of positive catalysts — Improving fundamentals or capital inflows triggering price increases

How to Protect Yourself During a Short Squeeze

For short traders, a short squeeze is a deadly threat. Here are practical tips:

Set a safe exit point
Monitor short interest and RSI indicator. When RSI drops below 20, the market is oversold and approaching reversal. Even if you’re in profit, decisively exit, because a rebound could wipe out all gains instantly.

Abandon the obsession with small gains or small losses
If short interest is clearly high (over 50%), even if the stock remains weak, reduce your position early. Safe exit is always better than greed.

Be extra cautious when participating in a short squeeze
If you decide to join a short squeeze, continuously monitor short interest changes. As soon as signs of short covering appear, take profits immediately—don’t wait for a market reversal and regret it.

Proper Long-term Risk Management

To fundamentally avoid the devastating effects of a short squeeze, investors should adopt these strategies:

Prioritize large-cap indices and blue-chip stocks
These assets have ample liquidity and are unlikely to have extreme short interest, making short squeezes nearly impossible.

Short during rebounds
Avoid establishing short positions at the bottom. Wait for clear rebound signals before shorting, increasing your success rate.

Use CFD contracts instead of borrowing stocks to short
CFDs offer leverage that you can control, providing more flexible risk management without the passive risk of forced covering.

Build hedged portfolios
Buy good stocks for long positions while moderately shorting major indices. With a 1:1 ratio, as long as individual stocks outperform the market, you profit regardless of market direction.

Final Advice

A short squeeze is like a mirage in the desert—appearing profitable but hiding deadly risks. The maximum profit from shorting is when the stock price drops to zero, but the potential loss is much greater than the gains—this is the cruel truth of short selling.

Rather than obsessing over shorting overvalued stocks, spend more effort studying fundamentals and market sentiment signals. A single piece of good news can wipe out years of shorting efforts. This is not alarmist talk but a lesson repeatedly taught by the market to every investor.

The secret to surviving longer in a bear market is understanding what a short squeeze means, respecting market forces, and exiting decisively when the time comes.