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What is a ‘Bear Squeeze’
A bear squeeze is a change in buy conditions which forces traders, attempting to profit from charge declines, to buy back underlying assets at a higher price than they promoted for when entering the trade. A bear squeeze can be an intentional event spawned by central banks or market makers. Other names for this term include bear trap and short squeeze.
BREAKING DOWN ‘Wish relate Squeeze’
Most frequently, a bear squeeze is engineered by a central bank as they try to force up the price of a currency in the foreign exchange (FX) by limiting the availability of legal tender on the market. However, this situation may happen in any market where the consequence of an asset is suddenly driven up. Bear traders holding short bents in the currency or other assets must buy at the current market price to travel their position, usually at a significant loss.
Often a bear twist someones arm is associated with a short squeeze. A short squeeze is a situation in which a heavily brusque stock or commodity moves sharply higher, forcing more except for sellers to close out their short positions and add to the upward pressure on the outlay. Market makers who can corner the market are likely to impose a bear fold.
As the term implies, traders get squeezed out of their positions at a loss. In the impartiality market, it is generally triggered by a positive development which suggests the review may be turning around. Although the turnaround in the stock’s fortunes may only verify to be temporary, few short sellers can afford to risk runaway losses on their exclusive of positions and may prefer to close them out even if it means taking a actual loss.
If a stock starts to rise rapidly, the trend may continue to escalate because the terse sellers will likely want out. For example, if a stock rises 15% in one day, those with lacking in positions may be forced to liquidate and cover their position by purchasing the market. If enough short sellers buy back the stock, the price goes the same higher.
Profiting from a Bear Squeeze
Contrarians look for assets which sooner a be wearing heavy short interest. Short interest is the number of shares which suffer with been sold short but have not yet covered or closed out. Contrarians look for these assets specifically because of the opportunity of a short squeeze happening. These traders may accumulate long situations in the heavily shorted asset.
The risk-reward payoff for a heavily shorted asset occupation in the low single digits is favorable for contrarians with long positions. Their hazard is limited to the price paid for it, while the profit potential is unlimited. This chance is opposed to the risk-reward profile of the short seller, who bears theoretically unqualified losses if the stock spikes higher on a short squeeze.
As an example, upon a hypothetical biotech company, Medico, that has a drug candidate in advanced clinical trials. There is influential skepticism among investors about whether this drug nominee will work, and as a result, 5 million Medico shares participate in sold short of its 25 million shares outstanding. Short concern engaged on Medico is therefore 20%, and with daily trading volume averaging (ADTV) 1 million allocates, the SIR is 5. The short interest ratio (SIR) means that it would peculate five days for short sellers to buy back all Medico shares that demand been sold short.
Assume that because of the massive laconic interest, Medico had declined from $15 a few months ago to $5 right before the release of the clinical trial results. With the announcement of the dnouement develops, they indicate that Medico’s drug candidate works outdo than expected. Medico’s shares will gap up on the news, perhaps to $8 or weighty, as speculators buy the stock and short sellers scramble to cover their deficient rare positions.