Anticipating and exploiting short-term bottlenecks has grow to be increasingly popular as an investment tactic in recent times. The GameStop short squeeze, cheered by motivated retail investors on web forums, is a vivid example of this phenomenon.
The ideal consequence for a possible short squeezer is what we call the short squeeze trifecta: they need to recognize the short squeeze before it happens, successfully exploit the stock as its value increases on the best way up, and Get out before the value rises falls back to earth.
Stocks that get right into a short squeeze typically have two well-known determinants: They have high short interest and are barely traded. But do other aspects play a job? We wondered whether certain macroeconomic conditions is likely to be correlated with a greater variety of short squeezes, or whether short squeezes are more common in certain sectors.
Our evaluation shows that two additional aspects are related to increased short squeeze activity: increased market uncertainty and speculative technologies with yet-to-be-determined long-term value.
Strict and loose short squeezes
To study short squeezes over time, we first needed to develop a way to find out whether or not they actually happened. Using data from all publicly traded US firms from 1972 to 2022, we defined two different categories of short squeezes: “strict” and “loose”. A strict short squeeze occurs when the value of a stock rises by 50 to 500% inside a month after which falls again to 80 to 120% of the previous value. The same pattern occurs with loose pressure, but over a two-month period.
This approach identified 1,051 tight short squeezes and 5,969 loose short squeezes over the sample period. The results for strict short squeezes are shown below. The loose method showed qualitatively similar results.
Strict short squeezes per yr
The variety of severe short squeezes fluctuated significantly over time. In a few years the worth was near zero, in others it was above 100. The five most energetic short squeeze months, normalized by the overall variety of current stock quotes, were February 2021, May 2020, October 2008, February 2000 and October 1974.
Turbulent times
What do all these months have in common? They fell at a time of utmost market uncertainty. For example, February 2021 saw a renewed spike in inflation and COVID-19 infections. In May 2020, the pandemic had turned life as we understand it the wrong way up. The global financial crisis (GFC) and the associated panic were in full swing in October 2008. In February 2000, the dot-com bubble approached its speculative peak before starting its subsequent downward spiral. In October 1974, high inflation, oil price shocks, and a severe recession took center stage, and the Federal Reserve soon began cutting rates of interest, prioritizing economic growth over reducing inflation. Therefore, difficult times for markets and the broader economy are likely to be good times for brief squeezes.
Technology not yet proven
How did severe short squeezes differ by sector? They occurred most steadily in biotech, with 20 in 2000 and 23 in 2020. These were the years with the best short squeezes across all sectors. Software and computers were the second most underestimated sector.
Strict short squeezes by sector
The biotechnology, software and computer industries rely heavily on latest and infrequently untested technologies. This makes them more vulnerable to speculation, harder to value and, as our data shows, more likely targets for brief squeezes.
In contrast, railways, accommodation and life insurance sectors are the least pressured sectors. They all have established, well-understood business models and little uncertainty about their valuations. They will not be very attractive for potential short squeezers.
So, to find out whether a stock might be the goal of a brief squeeze, 4 criteria should be considered: Is the stock being shorted? Is it barely traded? Is it based on unproven technology? Are macro conditions particularly unstable?
Of course, short squeezes will not be particularly common phenomena. So even when all 4 conditions apply, the possibilities of predicting one are still very high. And as GameStop shows, there are at all times outliers. While these 4 aspects help discover short-term squeezes before they occur, their course – how quickly they peak and crash again – will at all times be tense and unsure. For this reason, short squeezes are waves that you should not put an excessive amount of emphasis on catching and riding.
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