Short sales are one of the most used techniques by traders to take advantage of different assets, including Bitcoin.
With them, it is possible to take advantage of downward movements, manage downward risk or hedge another position.
Although they can be used for excellent strategies, they often carry potential risk. Firstly because there is no upper limit on a price; and secondly, which we are talking about today, short squeezes.
What are short selling squeezes?
They occur when many short sellers get stuck, and try to get out as quickly as possible in an attempt to cut losses.
When a short sale is made through contracts, the trader assumes responsibility for returning the asset at the same price, and tries to buy down in order to make a profit.
But when the Bitcoin Code opposite happens, he must assume the difference between the entry and exit price as a loss, and fulfill the contract with the counterparty.
Although sellers are clearly a downward pressure, strong upward movements cause them to move quickly to the other side, trying to buy as soon as possible, in order to pay the least possible price difference.
As short traders close their positions, a cascading effect is generated with buy orders adding fuel to the fire.
As a result of this situation, explosive upward movements occur.
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Is there such a thing as a long squeeze?
The same applies in the opposite case, although it is usually less likely to happen.
A long squeeze happens when bullish players get trapped by strong sales, and try to get out at the nearest price. They increase the downward pressure, injecting supply into the market.
Just as short selling can increase risk, markets that do not have the ability to use it can be affected by large price bubbles.
This is because as long as there are no people interested in short selling, there will be no upward pressure, and the price can continue to rise for a long time.
Traders use the long/short ratio to monitor market sentiment, and with them it is possible to forecast the strength of a squeeze.
When there are more short positions than long ones, there is more liquidity to increase the cascading effect of a short squeeze.