What Is a Long Squeeze?

Long Squeezes Explained in Less Than 5 Minutes

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When you invest in a stock and the price unexpectedly drops, you may feel pressure to sell to avoid losing money. If many investors try to sell at the same time, a long squeeze may ensue. A long squeeze occurs when the price of an asset drops and investors sell off their positions to avoid further losses, which causes the price to fall even more.

Long squeezes are relatively rare compared with the short squeezes that frequently make news. We’ll explain how a long squeeze works and how it compares with a short squeeze.

Definition and Examples of a Long Squeeze

A long squeeze is when a stock or another asset drops suddenly. Investors who have a long position—meaning they own the asset—rush to sell it, which causes the price to drop even further.

A long squeeze is the opposite of a short squeeze. Investors who take a long position are betting that the asset’s value will rise over time. But investors with a short position seek to profit from a price drop. Essentially, they borrow an asset and sell it in hopes of buying it back at a lower price and profiting off the difference. A short squeeze happens when investors with a short position panic and rush to close out their positions, driving up the price further.

When you invest on margin, meaning you’re investing using borrowed money from your broker, you’re at greater risk of having to sell in a long squeeze. When the price of your securities drops, you could face a margin call. Your broker can require you to immediately deposit additional cash or securities, or they can sell the assets of their choosing.

Long squeezes can also occur in commodity markets. An example of a long squeeze occurred in April 2020, when the price of a futures contract for West Texas Intermediate, the U.S. benchmark for crude oil, went negative for the first time in history. On April 20, 2020, the price of a futures contract with a settlement date in May 2020 dropped by $55.90, closing at negative $37.62 per barrel.

In commodities trading, traders need to sell their futures contract before the expiration date to avoid having to take physical delivery of the commodity—oil, in this case. But with demand for oil plummeting due to COVID-19 and an oversupply triggered by increased production, traders who were unable to accept physical delivery needed to exit their positions quickly. Otherwise, they’d face hefty penalties and fines.

Long Squeeze vs. Short Squeeze

Long Squeeze Short Squeeze
Occurs when investors who own an asset sell all at once Occurs when investors who have shorted a stock rush to close out that short position
Drives prices down Drives prices up
Less common More common
Losses are limited to the price of the security Unlimited potential for losses
Traders profit if they have a short position Traders profit if they have a long position

How a Long Squeeze Works

Long squeezes are relatively rare compared with short squeezes. They’re also less risky for investors. A long squeeze drives down the price of an asset, meaning those with a short position stand to profit. But when you have a long position, the worst-case scenario is that its price drops to zero. In that case, your loss is the amount you paid for the investment.

In a short squeeze, the asset’s price soars. As a result, investors with long positions profit. Because there’s theoretically no limit on how high an asset’s price can climb, investors with short positions face unlimited potential losses during a short squeeze.

What It Means for Individual Investors

A stock is more vulnerable to a long squeeze if it has a limited float, which is the number of shares available to the public. When there’s a limited float, it takes fewer people to have a major influence on the price.

The short interest ratio is the percentage of outstanding shares that have been shorted. A rising short interest ratio suggests investors are bearish on a security, while a decreasing short interest ratio tells you the market is bullish about it.

Likewise, if the price has risen rapidly, the market may decide the stock is overvalued, particularly if there’s bad news that affects the company. For example, if management reports poor financial performance, the stock’s price may drop, which could trigger other investors to sell off, leading the stock price to tank even more.

Even though it’s technically possible to lose the entire amount you invested in a long squeeze, that’s unlikely to happen. The key goal of value investors is to find stocks and other assets that the market has underpriced. If an asset price drops significantly, it’s likely that a value investor would seize on the opportunity to buy it.

Key Takeaways

  • A long squeeze occurs when the price of an asset drops and investors with long positions rush to sell, which causes further price drops.
  • An investor’s potential losses during a long squeeze are limited to what they paid for the asset, whereas during a short squeeze, investors with short positions theoretically face unlimited losses.
  • Stocks are most vulnerable to a short squeeze if they have limited float or if the price has increased rapidly.