What Is a Bear Squeeze?
A bear squeeze is a situation where sellers are forced to cover their positions as prices suddenly ratchet higher, adding to the expanding bullish momentum.
Understanding a Bear Squeeze
A bear squeeze is a sudden change in market conditions that powers traders, endeavoring to profit from price declines, to buy back underlying assets at a higher price than they sold for while entering the trade. As the term infers, traders get squeezed out of their positions, ordinarily at a loss.
A bear squeeze can be an intentional event encouraged by financial specialists, for example, central banks, or it very well may be a side-effect of market psychology where market makers, exploiting winding down selling pressure, strengthen their buying efforts to push that security's price higher. A bear squeeze designed by a central bank is finished with the intent of setting up the price of a currency in the foreign exchange market (FX). This is achieved overwhelmingly of that currency, basically lessening the accessible supply in the market, which brings about that currency appreciating pointedly and setting off a bear squeeze.
While it is more normal in the currency markets, a bear squeeze can occur in any market where the price of an asset is suddenly driven up. Sellers holding short positions in currencies, or different assets, must buy at the predominant market price to cover their position, which, given the speed of the move, frequently brings about critical losses.
Frequently a bear squeeze is related with a short squeeze, a phrase that is more famous with the average investor. A short squeeze is a situation where an intensely shorted security, for example, a stock or commodity, moves strongly higher, driving all the more short sellers to close out their short positions, which just adds to the vertical pressure on that security's price. Market producers who can corner the market are probably going to start a bear squeeze on the off chance that they consider the conditions to be ready for such an event.
In the equity market, a bear squeeze is generally set off by a positive development that recommends the stock might pivot. Albeit the turnaround in the stock's fortunes may just end up being impermanent, not many short sellers can stand to risk runaway losses on their short positions and may like to close them out, even on the off chance that it means assuming a substantial loss.
On the off chance that a stock begins to rise quickly, the trend might keep on heightening on the grounds that the short sellers will probably need out. For instance, on the off chance that a stock rises 15% in one day, those with short positions might be forced to liquidate and cover their position by purchasing the stock. Assuming an adequate number of short sellers buy back the stock, the price goes even higher.
Profiting from a Bear Squeeze
Contrarians search for assets that have heavy short interest — the number of shares that have been sold short however have not yet been covered or closed out. Contrarians search for these assets explicitly as a result of the chance of a short squeeze occurring and may collect long positions in the vigorously shorted asset.
The risk-reward payoff for a vigorously shorted asset trading in the low single digits is good for contrarians with long positions. Their risk is limited to the price paid for it, while the profit potential is unlimited. This risk is against the risk-reward profile of the short seller who, hypothetically, bears unlimited losses if the stock spikes higher on a short squeeze.
Illustration of a Bear Squeeze
Consider a theoretical biotech company, Medico, that has a medication candidate in advanced clinical trials. There is impressive doubt among investors about whether this medication candidate will work and, accordingly, five million of Medico's 25 million outstanding shares have been shorted. Short interest on Medico is accordingly 20%, and with average daily trading volume (ADTV) of 1,000,000 shares, the short interest ratio (SIR) is five. This basically means that it would require five days for short sellers to buy back all Medico shares that have been sold short.
Expect that due to the huge short interest, Medico had declined from $15 a couple of months prior to $5 shortly before the release of the clinical trial results. The announcement of the outcomes demonstrate that Medico's medication candidate works better than expected. Medico's shares will gap up on the news, maybe to $8 or higher, as examiners buy the stock and short-sellers scramble to cover their short positions, which prompts further buying and further appreciation of Medico's stock.
- Contrarian traders collect long positions in vigorously shorted assets in the expectations that a bear squeeze may in the off.
- A bear squeeze can be an intentional event hastened by financial specialists, like central banks, or it very well may be a result of market psychology where market creators, exploiting disappearing selling pressure, strengthen their buying efforts to push that security's price higher.
- A bear squeeze is a situation where sellers are forced to cover their positions as prices suddenly ratchet higher, adding to the thriving bullish momentum.