What is a “Short Squeeze”?
A Short Squeeze is when a large amount of short players are forced by a bump in buying to cover their short positions in fear of even larger losses.
Being a trader that is short selling means that they are selling something that they don’t own. To do this, the seller must borrow Bitcoin from an exchange. And in return, the the short seller pays a small fee to the original lender. Once the seller buys the Bitcoin back, the “loan” is completed and done. The player makes a profit off of this by receiving the difference between the sale price and the purchase price, or has to pay the loss. This is why it gets risky and short sellers are quick to buy. Their losses could be potentially unlimited if they hold.
Sellers with short positions are predominantly small to medium term traders. They are not investors that want to ride out the volatility. Short trades are taken on margin, and if the market jumps up against their positions they may be required to liquidate it.
With a small jump acting as a catalyst, traders begin to panic and cover their positions with a buy order. There is then a snowball effect and a mass exodus of short positions creates tremendous buying pressure. In turn, this triggers buys on the rest of the short players. For a short player to close their trades, they need to place an order opposite in the form of buying the cryptocurrency. The price can start rising causing some more shorts to cover, which causes other shorts to cover. There is also the rest of the traders and investors watching this movement happening and piling on board long.
Bitcoin Shorts At All Time Highs
The sheer number of short orders prior to the rise early this morning was at an all time high. Those short sellers have been accumulating as Bitcoin moved sideways this last month all the way up to 40,000 positions opened on exchanges. Once these orders being to close, there will be an equal number of new buy orders in their place. There only needs to be a small catalyst in a market as thin as Bitcoin to trigger the first few orders.
The size and speed of the drop off in short positions indicates the stops of the short sellers were hit and snowballed into the move we saw in Bitcoin. Orders are now half of what they were prior. A decline, like the chart shows above, is not an organic surge in sellers but orders being triggered.
There are a multitude of factors that may have influenced this recent volume spike, but before blaming manipulation and regulation, consider that traders are trying to cover their hides as money gets lost on the short squeeze.