Recently, many beginners have been discussing short selling, but most people overlook the most powerful risk — short squeeze. This is not a new concept, but few truly understand it.

A short squeeze, also called a "gag" or "cover," simply refers to the process where short sellers are forced out of the market. When the stock price rises rapidly, short sellers are compelled to buy back shares at high prices to cover their positions, which further drives up the stock price, creating a vicious cycle. It sounds terrifying, but once you understand how it works, it’s not so easy to get caught.

There are three ways to short: borrowing shares to sell, futures, or CFD contracts. No matter which method you use, if the stock price keeps rising strongly, insufficient margin will force liquidation, making it easy to get caught in a short squeeze. Especially when many people bet on a decline simultaneously, if there’s capital or news deliberately pushing the stock price higher, it creates perfect conditions for a short squeeze.

The most memorable case for me is the GME incident. In early 2021, Wall Street institutions heavily shorted this gaming company, with short positions exceeding 140% of the total shares. As a result, retail investors on Reddit united to buy in, causing the stock price to skyrocket from $30 to $483. Short sellers, due to margin calls, were forced to cover, reportedly losing over $5 billion. A week later, the stock price quickly fell back, and those retail investors who bought in were also caught in the trap.

Tesla’s situation was different. It wasn’t deliberately squeezed, but rather the company’s fundamentals genuinely improved. From consecutive losses to turning profitable in 2020, the stock price surged nearly 20 times in just two years. Short sellers never expected electric vehicles to become so popular, and they suffered significant losses as a result.

Both cases illustrate one key point: a short squeeze isn’t necessarily manipulation; sometimes it’s just a natural market reaction. But regardless of the cause, the risk for short sellers is enormous. The profit potential for shorting is limited, but the losses are theoretically unlimited.

How to judge if a stock has short squeeze risk? I usually look at three indicators. First, whether the short interest exceeds 40-50% of the circulating shares. If so, it indicates too many bets on one side, and the risk is high. Second, whether trading volume suddenly spikes. Third, using the RSI indicator to gauge market momentum. An RSI below 20 indicates an oversold condition, and the price is likely to reverse, so it’s best to exit promptly.

If you really want to short, my advice is not to ask “Will this stock fall?” but rather “Can I control the maximum loss of this short position?”, “Is there a clear stop-loss?”, and “Are there conditions for a short squeeze?” Especially when short interest is high, trading volume increases, and the stock price breaks above key moving averages, the market odds may already be unfavorable for shorts. At this point, the smartest move is often not to hold on stubbornly but to reduce or exit the position. Because once the risk of losses worsens, it’s usually not a matter of “waiting it out,” but rather becoming more dangerous the longer you delay.

To avoid short squeeze scenarios, choosing the right assets is crucial. Major indices or large-cap stocks are safer options because they have huge liquidity, making it less likely for short positions to become overly concentrated. In terms of tools, in a bearish market, shorting stocks via borrowing is less recommended because it can lead to forced buy-ins. CFDs are more suitable, as they allow adjustable leverage, two-way trading, and no expiration date. Some platforms also support preset stop-loss and take-profit orders, which are convenient for flexible shorting.

An advanced strategy is hedging: buy individual stocks long while shorting the broader market. If the stock outperforms the market or falls less than the market, you can profit from the difference. This approach effectively hedges risk.

Finally, I want to say that short squeeze is scary not only because it can cause rapid gains but also because it can lead traders into asymmetric losses without them realizing it. However, it usually doesn’t appear out of nowhere; it’s often triggered by high short interest, poor liquidity, emotional trading, plus a news event or a spark of capital. Mature traders don’t just jump in when they see a squeeze or shorting opportunities; they first assess whether the risk-reward ratio is reasonable. As long as you can evaluate the odds before entering a trade, a short squeeze won’t be an unpredictable black swan but a risk that must be taken seriously during trading.