How does short squeezing occur? What is the meaning of "嘎空" and its corresponding approach

Being long is steady and profitable, while shorting carries great risk—this phrase has been circulating in financial markets for a long time. But the biggest hidden danger faced by many short investors is the sudden arrival of a “short squeeze” market. When short positions are overly heavy and the market suddenly turns, short sellers may encounter huge losses in an instant. So, what exactly does a short squeeze mean? Why does it form? And how should one respond?

1. The Essence of a Short Squeeze: Chain Reaction of Forced Liquidation

Short Squeeze, also known as “short covering,” refers to a situation where the price of a shorted asset skyrockets, forcing short sellers to buy back the asset at high prices to close their positions, further pushing up the asset’s price. In simple terms, a short squeeze means short sellers are caught in a passive covering dilemma.

Short squeezes can be divided into two scenarios: one is when the stock price rebounds too quickly, forcing short sellers to cover at high prices; the other is when institutions or groups with pricing power deliberately inflate the stock price to force short sellers to cut losses, profiting from the move.

Before delving into short squeezes, it’s important to understand the logic of “short selling.” Short selling is a form of inverse trading—investors expect a target to decline, so they sell first, then buy back at lower prices to profit from the difference. But how can one short without owning the underlying asset?

There are mainly three ways to short:

First, borrowing stocks from shareholders. Borrowing stocks from long-term holders in the market, paying interest, selling them, and then buying back at lower prices to return to the original shareholders.

Second, using futures contracts. Investors pay margin to short the underlying asset, but futures require rollover at expiration, and one must beware of rising prices leading to margin calls or forced liquidation.

Third, using spread contracts (like options or CFDs). Compared to futures, these don’t require rollover but still carry margin risks.

No matter which method is used, if the underlying asset’s price continues to rise, short sellers may face margin calls. If the rise is sharp, brokers may forcibly liquidate positions, which is the root cause of a short squeeze disaster.

2. Why Does a Short Squeeze Occur?

Short squeezes result from both speculative actions and natural buying driven by improving fundamentals.

When a stock is perceived as severely overvalued, speculative investors start borrowing stocks from brokers to short. These short positions are exposed to market participants. Usually, the short ratio isn’t very high, and the market doesn’t pay much attention. But once the short ratio exceeds 50% of the circulating shares, it becomes a target for market attack.

Specific case: GME vs. Wall Street

Before 2020, GME was a company selling gaming consoles, struggling due to the popularity of online gaming, with its stock price continuously falling. In September 2020, Canadian entrepreneur Ryan Cohen took a large stake and joined the board, aiming to revive the company. Inspired, the stock price rose from single digits to nearly $20.

Subsequently, several Wall Street institutions issued reports claiming GME was overvalued and recommended short selling. Due to GME’s small market cap and limited trading volume, institutional short selling became dominant. Surprisingly, short positions even reached 140% of the float—an obviously excessive shorting situation.

This news ignited the Reddit forum WSB. Netizens called for collective buying of GME to fight Wall Street. The result: on January 13, 2021, the stock surged 50% to $30, and two weeks later (January 28) soared to a high of $483.

The uncontrolled surge in stock price forced short sellers to cover due to margin exhaustion. Reports indicate that short sellers lost over $5 billion in this short squeeze event. Afterwards, the stock price quickly retreated, dropping more than 80% within a week. After this battle, WSB members continued to target other stocks with high short ratios, such as AMC and BlackBerry, which also experienced rapid rises and sharp declines in a short period.

Long-term rise driven by improving fundamentals: Tesla case

Unlike the short-term GME squeeze, Tesla demonstrated a long-term bull market driven by fundamental improvements.

Tesla, as a leader in electric vehicles, initially faced losses due to low sales but was led by Elon Musk to innovate boldly. Despite initial losses, EVs were widely regarded as the future trend, and Tesla’s stock price kept rising. With high liquidity and large market cap, Tesla became one of the stocks with the largest short positions.

The turning point came in 2020. Tesla turned profitable, with the Shanghai Gigafactory contributing explosive revenue growth, causing the stock to surge. Within half a year, the stock price rose from $350 to $2,318, nearly a 6-fold increase. Later, the company implemented a 1-for-5 stock split, and within a year, the stock price rose from over $400 to over $1,200 (peak at $1,243). Over two years, the stock appreciated nearly 20 times, causing heavy losses for short sellers.

This is a classic example of a fundamental-driven price increase, aided by global QE monetary easing policies in 2020.

3. Strategies to Respond to Short Squeezes

A short squeeze is like a “black swan” in the financial market—once it occurs, it can cause devastating losses. How can short investors protect themselves?

Strategy 1: Set stop-loss levels at high short ratios

When the short ratio exceeds 50% of the float, even if the stock performs poorly, it’s wise to reduce or close positions early. Accept small gains or small losses; the key is to stay alive and exit.

At this point, observe technical indicators, especially RSI (Relative Strength Index). When RSI is between 50 and 80, it indicates bullish strength; the market is suitable for long positions. When RSI drops below 20, the market is oversold, and the risk of reversal is high. Short investors should exit decisively when RSI falls below 20 to avoid falling into a short squeeze trap.

Strategy 2: Take profits in time

If you want to follow a short squeeze rally for long positions, monitor short positions closely. As long as short positions keep increasing, long traders can continue participating. But once short covering begins, exit immediately. These buying behaviors are not based on fundamentals but are forced covers. Once the squeeze ends, prices tend to revert rapidly to fair value, with volatile swings.

4. How to Safely Short Stocks

Short squeeze markets usually require two conditions: overly concentrated short positions and high market attention.

For investors, choosing major indices or large-cap stocks for shorting is relatively safer. These assets have high liquidity and are less likely to have excessive short concentration.

In a bearish market environment, it’s recommended to short during market rebounds, avoiding blindly chasing after shorts. Traditional “borrowing stocks to short” carries higher risks of forced covering. Using spread contracts (like options or CFDs) offers more flexible leverage control.

Another risk-balanced strategy is to: buy fundamentally good stocks for long positions while shorting the broader market for hedging, maintaining a 1:1 ratio. As long as the stock outperforms the market in gains or underperforms in declines, investors can profit.

Short squeeze scenarios can be deadly for short sellers. While closely monitoring order flow, investors should also deeply analyze the stock’s fundamentals and news changes, because a single positive piece of news can wipe out a short position. Only by fully understanding the nature and risks of short squeezes can one seek opportunities amid risks.