Recently, I've seen many friends discussing short-selling strategies, but many overlook a deadly risk — short squeeze. This isn't new, but every time it occurs, it can catch unprepared short investors off guard.

Let me first explain what a short squeeze is. Simply put, it's the process where short sellers are "squeezed out" of the market. When more and more investors are shorting a stock, but the price starts to rise in the opposite direction, these short sellers are forced to buy back shares at higher prices to cut losses. As more buying pressure enters, the stock price surges even more, and short sellers face increasing losses — this is the terrifying nature of a short squeeze.

There are three main ways to short: borrowing stocks to sell, using futures, or trading CFD spread contracts. But regardless of the tool, as long as the stock price keeps rising rapidly, short sellers with insufficient margin will be forcibly liquidated by brokers, and then caught in a short squeeze.

Why does a short squeeze happen? Usually, several conditions must occur simultaneously: a large short position, a small circulating share count, high market attention, plus sudden positive news or major capital inflows. Once these conditions align, the stock price can rise rapidly, forcing short sellers to cover, creating a classic short squeeze.

The 2021 GME incident is the most iconic example. This gaming company had a small share base, yet Wall Street institutions borrowed over 140% of its shares to short. The result was a coordinated attack by retail investors on Reddit. The stock price soared from single digits to $483, with short sellers reportedly losing over $5 billion. Afterwards, the price quickly dropped 80%, and those buying were purely for the squeeze, ignoring fundamentals.

Tesla's case is different. TSLA, one of the most heavily shorted stocks, saw its fundamentals genuinely improve — turning profitable in 2020, exploding its Shanghai factory, and establishing the electric vehicle trend. In just two years, the stock price nearly 20 times higher, and short sellers suffered heavy losses. But this was driven by fundamentals, not a short squeeze.

If you want to short, I recommend asking yourself three questions first: Can you control the maximum loss of this short position? Is there a clear stop-loss if the price moves against you? Does this stock have the conditions for a short squeeze? Especially note that when the short ratio is high, trading volume suddenly spikes, and the price breaks above key moving averages, the market odds are already unfavorable for shorts. At this point, the best approach isn't to hold stubbornly but to reduce or exit the position.

The key to managing short squeeze risk is whether you can safely exit when the market turns. If a stock's short position exceeds 40-50% of the circulating shares, it indicates many traders are shorting the same stock. Once positive news hits, the risk of a squeeze increases. You can observe the RSI indicator; below 20 indicates an oversold condition, meaning the market is irrational, and a reversal is likely. At this point, it's best to exit promptly.

Those wanting to participate in short squeeze plays should also be cautious. If short positions haven't decreased but continue to grow, they can push the stock price higher. But once short covering begins, it's wise to take profits early. These buying pressures are not based on confidence in the company but just short covering. When the squeeze ends, the stock price can quickly fall back to reasonable levels.

To avoid being hurt by a short squeeze, choosing the right assets and tools is crucial. Major indices or large-cap stocks are less likely to have excessively high short positions because of their huge liquidity. In a bear market, borrowing stocks for shorting can lead to forced buy-ins, whereas CFD spread contracts are more suitable — they allow adjustable leverage, no expiration date, and both long and short positions. Some platforms also support preset stop-loss and take-profit orders, making flexible shorting easier for investors.

True traders don't rush in at the sight of a short squeeze, nor do they short just because of bearish signals. Instead, they assess whether the risk-reward ratio of the trade is reasonable. As long as you analyze the odds beforehand and decide whether to enter, a short squeeze won't be an unpredictable black swan but a risk that must be taken seriously during trading.