Anticipating and riding short squeezes has become a popular investment tactic in recent years. The GameStop short squeeze, activated by an aspiring private investor on an Internet message board, is a vivid example of this phenomenon.
The ideal result for a future short squeezer is what we call a short squeeze trifector. In other words, you need to spot short squeezers before they occur, ride stocks well as they surge in value, and bail them out before prices soar. fall to earth.
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Stocks that end in short squeezes tend to exhibit two well-known determinants. Short interest rates are high and trading volumes are low. But are other factors at play? We wondered if certain macro conditions correlated with an increase in short squeeze, or if short squeeze was more common in certain sectors.
Our analysis indicates that two additional factors are associated with increased short squeeze activity. It is a speculative technology whose long-term value has yet to be determined, along with increased market uncertainty.
tight loose short squeeze
To study short squeezes over time, we first had to develop a methodology to see if they actually happened.Using data for all publicly traded US companies from 1972 to 2022 We classified the short squeezes into two different categories: “strict” and “loose.” A hard short squeeze is when the stock price rises by 50% to 500% over the course of a month and then falls by 80% to 120% of its original value. The same pattern occurs with the loose squeeze, but it takes longer than 2 months.
This approach identified 1,051 tight short squeezes and 5,969 loose short squeezes during the study period. Here are the results for the tight short squeeze. The loose method gave qualitatively similar results.
strict short squeeze by year
![Graph of number of strict short squeezes by year](https://i0.wp.com/blogs.cfainstitute.org/investor/files/2023/01/Strict-Short-Squeezes-by-Year.png?resize=640%2C267)
The number of strict short squeezes varied significantly over time. Some years it was close to zero and some years it was over 100. The five most active short squeeze months, normalized by total number of current stock listings, were February 2021, May 2020, October 2008, February 2000, and October 1974.
tumultuous times
What do all these months have in common? They fell amid periods of extreme market uncertainty. Inflation and his COVID-19 infection, for example, flared up again in February 2021. In May 2020, the pandemic changed our lives. In October 2008, the Global Financial Crisis (GFC) and the panic that followed was in full swing. In October 1974, with high inflation, an oil price shock, and a deep recession all at the forefront, the US Federal Reserve (Fed) immediately began cutting interest rates, putting the economy at risk rather than keeping inflation in check. Prioritize growth. As such, tough times for markets and the economy as a whole tend to be good times for short-term squeezes.
unproven technology
How did strict short squeezes vary by sector? Biotech was the most frequent occurrence, with 20 in 2000 and 23 in 2020. Software and computing was the second most common short squeeze sector.
Strict Short Squeeze by Sector
![Chart showing short squeeze by sector](https://i1.wp.com/blogs.cfainstitute.org/investor/files/2023/01/short-squeezes-by-sector.png?resize=640%2C323)
The biotechnology, software and computing sectors rely heavily on new, often unproven technologies. This makes them more speculative, harder to evaluate, and, as the data shows, more likely to be a short-squeeze target.
In contrast, the least short-squeezed sectors are rail, lodging and life insurance. They all have well-established and well-understood business models with little uncertainty around valuation. They are hardly attractive to potential short squeezers.
Therefore, there are four criteria to keep in mind when determining whether a stock is likely to be short-sold. Are you thinly traded? Are you relying on unproven technology? Are macro conditions particularly unstable?
Admittedly, short squeeze is not a particularly common phenomenon, so even if all four conditions are true, the probability of predicting one is very high. Also, as GameStop shows, outliers are always present. Moreover, even if these four factors help identify a short squeeze before it occurs, its trajectory (how fast it reaches the apex and crashes) is always complex and uncertain. That’s why the short squeeze is a wave you shouldn’t bet too much on catching and riding.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, and the opinions expressed do not necessarily reflect those of CFA Institute or the author’s employer.
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