Short squeeze and long squeeze: how they happen - and what they mean for NEPSE

Some of the fastest moves in any market are not caused by good or bad news at all. They're caused by people who have to trade. A short squeeze is a sharp rise driven by traders who bet on a fall and are forced to buy back; a long squeeze is a sharp fall driven by buyers who borrowed money and are forced to sell. Here is how each one happens, step by step, the famous cases from GameStop to the oil market in 2020, and what it all means for NEPSE - where one kind of squeeze can already happen and the other could arrive with short selling.

First, two words: long and short

• Going long means buying a share and hoping it rises. This is what almost everyone on NEPSE does.
• Going short means selling a share you have borrowed, hoping to buy it back cheaper later and return it. Your profit is the fall. It isn't allowed on NEPSE yet - see our post on short selling and intraday trading in Nepal.

Both become dangerous when the trader is forced to close the position - by a stop-loss, by a lender asking for its money back (a margin call), or by a broker closing it for them. Forced trades don't care about price. That's the fuel of every squeeze.

How a short squeeze happens

1. A crowded bet on a fall. Many traders have shorted the same share. The more of them there are compared with the shares that actually trade, the more dangerous it gets.
2. A trigger. Good news, a big buyer, or simply a rise that the shorts didn't expect.
3. Losses grow - with no ceiling. A buyer can lose at most what they paid. A short seller's loss has no limit, because a price can keep rising. As it climbs, their stops are hit and lenders demand more money.
4. They must buy back. To close a short you have to buy the share. All those forced buy orders arrive at once - and push the price up further, which forces the next group of shorts to buy.
5. It ends when the shorts are gone. Once the forced buyers have bought, nobody is left to keep pushing. Squeezed prices usually fall back hard.

How a long squeeze happens

1. Buyers on borrowed money. Many holders bought with a margin loan - money borrowed against the shares themselves.
2. A trigger. Bad news, a big seller, a rate rise, or just a fall after a long run.
3. Margin calls. When the shares fall, they're worth less than the loan allows. The lender asks the borrower to add money or sell.
4. They must sell. Many can't add money, so they sell - or the lender sells for them. That selling pushes the price down further, which triggers the next round of margin calls.
5. It ends when the forced sellers are gone. The price usually overshoots on the way down, then bounces once the selling dries up.

Famous squeezes

GameStop, January 2021 (short squeeze)

Short sellers had bet so heavily against the US video-game shop that reported short interest was above 100% of the shares available to trade. Small investors, organised on online forums, kept buying. The share went from under $20 at the start of the month to an intraday high of $483 on 28 January. One hedge fund that had shorted it, Melvin Capital, lost more than half its money that month and needed a rescue of about $2.75 billion. Within weeks the price had fallen back below $50.

Volkswagen, October 2008 (short squeeze)

Hedge funds had shorted Volkswagen, expecting it to fall. Then Porsche revealed it controlled about 74% of the shares, directly and through options, while the state of Lower Saxony held about 20%. That left only a few percent free to trade - fewer than the short sellers needed to buy back. The price jumped from about €210 to over €1,000 in two days, and for a moment Volkswagen was the most valuable company in the world.

Oil, April 2020 (long squeeze)

When COVID stopped the world, US oil storage filled up. Traders holding May oil futures had to sell before the contracts expired or take delivery of oil they had nowhere to put. Forced selling with no buyers pushed the price below zero: on 20 April the May contract settled at minus $37.63 a barrel - sellers paid buyers to take it.

China, summer 2015 (long squeeze)

Chinese investors had borrowed heavily to buy shares. When the market turned in June 2015, margin calls forced selling, which forced more margin calls. The Shanghai index fell by about a third in a few weeks, and the government stepped in with emergency measures.

Crypto (both, regularly)

Crypto exchanges let traders borrow many times their money. A move of a few percent can close thousands of positions automatically in minutes - long squeezes on the way down, short squeezes on the way up - and those forced trades turn small moves into big ones.

What this means for NEPSE

Long squeezes can happen today

Nepali investors can borrow against their shares through margin loans from banks and brokers, and Nepal Rastra Bank has changed the limits on these loans several times. When NEPSE falls hard, margin calls arrive and some borrowers are forced to sell into a falling market. That doesn't cause every fall - but it can make a fall faster and deeper. NEPSE's slide from its peak of about 3,199 in August 2021 to around 1,815 two years later (a 43% drop) came while banks were tightening lending and rates were rising - classic long-squeeze conditions.

Short squeezes can't - yet

Without short selling there are no short sellers to squeeze. But NEPSE has a cousin of the short squeeze: the float squeeze. When a small group buys up most of the shares that actually trade, there are few sellers left, and even modest buying pushes the price up circuit after circuit. Traders chasing it are buying from almost nobody - and when the group sells, the fall can be just as fast. Our post on cornering on NEPSE shows how it works with real data.

If short selling arrives

SEBON has discussed allowing short selling. If it comes, NEPSE's thin trading would make squeezes more likely, not less: in a stock that trades only a few lakhs a day, a handful of short sellers rushing to buy back could send it straight to the upper circuit - where, with no sellers, they couldn't buy at all. Any short-selling rules will need limits on how much of a stock can be shorted and clear rules for the circuit.

How to avoid getting squeezed

• Be careful with margin loans. Borrowed money turns a normal fall into a forced sale at the worst moment. If you use one, borrow far less than the maximum.
• Size every position so a fall can't force you out. Decide your stop and your size before you buy.
• Don't chase a stock that's going up circuit after circuit on thin trading. Ask who is selling to you - often it's nobody, until it's everybody.
• Watch the crowd. When everyone is on the same side - everyone borrowed, everyone bullish - the squeeze risk is highest.
• Remember squeezes fade. The move is driven by forced trades, not by the company. When they're done, the price usually gives much of it back.

Sources - from the web: GameStop and Melvin Capital as reported by Reuters, CNBC and the US SEC's staff report on the January 2021 trading (Oct 2021); Volkswagen and Porsche (Oct 2008) as reported by Reuters and the Financial Times; WTI oil futures settlement on 20 April 2020 (CME, as reported by Reuters); China's 2015 market fall as reported by Reuters and the BBC; NEPSE index levels from NEPSE. Charts: MacroLens NP (illustrations). Cover photo: public domain. This is education, not investment advice.