Short sellers sell the stock first and later buy at a lower price in order to make profit. But sometimes the stock price goes up due to various reasons. In this case short sellers buy back the stock to prevent excess loss. Firstly there are long buyers who buy the stock due to various reasons, some of the reasons can be good earnings report from the company, positive outlook etc. Due to long buyers the price of the stock goes up and now there are short sellers too who end up buying the stock in order to limit their loss. This results in stock prices shooting up real quick and to greater prices. The price shooting up attracts new buyers who too want to make a profit by going long and as demand is greater the price of the stock shoots further high. This is known as short squeeze.
Let me explain this with an example. Imagine the price of a stock is ₹100 and you expect it to hit ₹95. So you sell the stock at ₹100. Now imagine there are more people who think like you and they too sold the stock assuming the price of the stock would fall. But due to some reason the stock price goes up, let’s assume it hits ₹102. Now all those short sellers who sold the stock at ₹100 are in a loss of ₹2. In order to prevent excess loss, the short sellers flock to buy the stock. This creates excess demand. Imagine there are 100 long buyers, now there are those 100 short sellers too who become buyers. All together there are 200 buyers. This results in price shooting up. Also some short sellers who do adjustment trades end up buying excess in order to overcome their losses. Basically they buy more and go long to cover losses. ₹100 to ₹102 is a ₹2 loss per share for a short seller. If the same dude goes long by buying at ₹102 and if the stock hits ₹105 he’ll make a ₹3 profit. As he made a loss of ₹2 earlier and now a profit of ₹3, the net profit is ₹1. People with sufficient capital can play the market in both directions, sometimes simultaneously, and if they are good at mathematics and finance they’ll find a way to make money in any type of situation and as long as the stock doesn’t go stagnant. We drifted away from the title of the post but yeah more demand means more buying and stock price shooting up.
Disclaimer : Trading stocks is subjected to market risks. Please read all the terms and conditions before investing. The motive of this lesson was to teach little things about stocks for those who do not understand much about stocks. Candidcanblog.com will not hold any responsibility for any losses incurred to the readers of this post.