"Ga Kong Trap" Investors Must Understand the Short Squeeze Risks and Self-Help Guide

In trading markets, short selling may seem like a quick way to profit, but it hides a risk powerful enough to bankrupt investors overnight—short squeeze. Many seasoned traders have suffered heavy losses during short squeeze events, making this phenomenon one of the most unpredictable and destructive threats to short investors. What exactly is a short squeeze? How should investors respond? This article will explore this critical issue in depth.

Understanding Short Squeeze: The Biggest Hidden Danger in Short Selling

Short Squeeze, known as “押空” in Chinese, is essentially a situation that forces short investors to cover their positions. When the price of a stock or asset that has been shorted rises sharply, these investors, betting on a decline, may be forced to buy back shares at higher prices due to margin calls, which in turn drives the price even higher, creating a vicious cycle.

There are three main ways to short sell: first, borrowing shares from long-term shareholders and selling them, then buying back at lower prices; second, trading futures contracts with margin to take opposite positions; third, using CFDs (Contracts for Difference), which also require margin deposits.

Regardless of the method, the fundamental characteristic of short selling is “limited profit, unlimited risk.” The maximum gain is when the stock price drops to zero, but potential losses can be infinite. This asymmetric risk-reward structure is the primary reason why short squeeze events can cause catastrophic losses.

How Does a Short Squeeze Form? Classic Cases from GME to Tesla

Short squeeze events typically arise under two conditions: excessive short positions and a sudden surge of buying interest. This buying pressure can come from natural market reactions or deliberate manipulation.

Market Attack: The GME Wall Street Battle

In 2020, Canadian entrepreneur Ryan Cohen heavily bought shares of the game retailer GME and joined the board to turn the company around. This news sparked investor enthusiasm, pushing the stock from single digits to nearly $20.

However, many Wall Street institutions believed GME was severely overvalued, issued bearish reports, and began massive shorting. Astonishingly, the amount of shorted shares exceeded the total outstanding shares, with a short interest ratio over 140%. This phenomenon caused a stir on the Reddit forum Wall Street Bets (WSB).

Retail investors familiar with GME banded together, buying large quantities of shares to fight against Wall Street. Starting January 13, 2021, the stock price skyrocketed from $30 to a peak of $483 within two weeks, a gain of over 15 times. Short sellers, due to margin calls, were forced to cover, with estimates of losses exceeding $5 billion. The stock then quickly retreated, indicating that the rally was mainly driven by a short squeeze rather than fundamental improvements.

Fundamental Shift: Tesla’s Remarkable Rise

Compared to GME’s orchestrated manipulation, Tesla’s rise exemplifies a natural fundamental turnaround. After Elon Musk took over, aggressive reforms were implemented. Although initially unprofitable, the company turned profitable in 2020 with the launch of the Shanghai Gigafactory.

Within half a year, Tesla’s stock price surged from around $350 to $2,318, nearly a 6-fold increase. After a 5-for-1 stock split, the price rose again from over $400 to surpass $1,000, reaching a peak of $1,243. In just two years, the stock appreciated nearly 20 times, causing devastating losses for short sellers.

Both cases clearly demonstrate that a short squeeze can be artificially engineered or a natural result of fundamental improvements. Regardless of the cause, it can be deadly for short investors.

Practical Strategies to Handle Short Squeeze Events

To survive short selling, investors must establish clear risk management mechanisms. Based on market experience, there are two core strategies:

1. Timely Stop-Loss

When short interest exceeds 50% of the circulating shares, even if the price remains weak, investors should consider closing positions early. Monitoring RSI (Relative Strength Index) can help: if RSI is between 50-80, it indicates buying strength outweighs selling; if RSI drops below 20, the market is oversold, and the risk of reversal is high—it’s best to exit immediately.

Small gains or losses are less important; staying alive is the priority. Many experienced traders confirm that timely stop-losses before a short squeeze can preserve capital and prepare for future opportunities.

2. Participating in Short Squeeze for Profit

If an investor chooses to join a short squeeze (i.e., follow the buying frenzy), they must closely monitor short interest changes. As long as short interest continues to grow and hasn’t started to cover, the upward momentum can be sustained; but once short positions begin to decrease, profits should be taken immediately.

This buying activity is often not based on company fundamentals but purely to force short covering. Once covering begins, the short squeeze ends, and the stock price can rapidly fall back to reasonable levels, with latecomers often left holding the bag.

Investment Wisdom to Avoid Falling into Short Squeeze Traps

Short squeeze events generally require two preconditions: abnormally high short interest and high market attention. To successfully short sell for profit, investors should follow these principles:

Prioritize large-cap assets. Major indices or blue-chip stocks, due to their high liquidity, rarely develop excessive short interest, making short squeeze events unlikely. Compared to small stocks, these assets carry lower risk.

Short during market rebounds. Bear markets often feature multiple rebounds; waiting for these rallies before shorting can reduce risk. Rushing into short positions prematurely is a common trait among short squeeze victims.

Choose appropriate shorting tools. Compared to borrowing stocks for shorting, CFDs offer more flexibility and less risk of forced liquidation. CFDs use margin but allow investors to adjust leverage more freely, enhancing risk control.

Use hedging strategies to reduce risk. A proven method is to simultaneously go long on selected stocks and short the broader market index—this hedges against overall market movements. If the stock outperforms the index, or the stock’s decline is less than the index, profits accrue; this approach effectively isolates short squeeze risks.

In today’s volatile markets, short squeeze has become a critical issue for investors. Whether experienced traders or newcomers, understanding its causes and warning signs is essential. Ultimately, remember: short selling is like walking on a cliff’s edge—safety and timely retreat are always more important than chasing that last dollar.