How dangerous is short selling? Why do short sellers end up losing everything?

An invisible “dark battle” is unfolding in the financial markets. Making money through long positions is quite straightforward; everyone knows how to play it. But short selling is a different story — it seems like a quick way to profit, but in reality, it hides a trap capable of destroying accounts: Short Squeeze (also known as Short Covering).

If short selling is dancing on the edge of a knife, then a short squeeze is when the knife suddenly turns around. In just two weeks, unrealized gains on paper can instantly turn into massive losses.

How to Play Short Selling? Three Approaches, Each with Its Pitfalls

Before understanding short squeezes, you must first grasp the essence of short selling. Simply put, it’s betting that a stock will fall.

There are three main ways to short sell:

1. Borrow Stocks to Sell Borrow stocks from long-term shareholders, pay interest, then sell. When the stock price drops, buy back to return the shares, pocketing the difference. Sounds simple, but the problem is—what if you don’t have stocks to borrow? The harsh answer: Forced Covering. If the stock price surges, brokers will close your position directly, whether you like it or not.

2. Futures Trading You only need to pay margin to short, with attractive leverage. But leverage is a double-edged sword. When the stock price skyrockets, your margin can be wiped out instantly.

3. CFD (Contract for Difference) No need to transfer ownership, but the risk of margin calls remains. If the market moves against you, a margin call notification may come crashing down.

Simple summary: The maximum profit from shorting is when the stock price drops to zero, but the risk has no upper limit. That’s why some say short selling is an investment method with “limited gains but unlimited risks.”

Why Do Short Squeezes Occur? Two Completely Different Scenarios

Scenario One: Capital Sniping — Pre-meditated Short Squeeze Events

The GME incident is the most classic example.

In 2020, Canadian entrepreneur Ryan Cohen heavily bought GameStop (GME) shares and joined the board, aiming to turn around this declining game retail company. Once the news broke, the stock soared from single digits to nearly $20. Several Wall Street institutions detected an opportunity, issuing reports claiming GME was severely overvalued and recommended shorting.

These institutional investors began large-scale borrowing to short. Key data: the shorted shares even exceeded 140% of GME’s total shares. Every short seller believed this “overhyped company” would eventually fall.

But they didn’t expect this news to blow up on the US social platform Reddit’s stock forum WSB (Wall Street Bets). A large number of netizens, outraged, decided to “unite and force Wall Street to admit defeat.”

What was the result?

• On January 13, 2021, the stock surged 50% to $30
• In just two weeks, by January 28, the price soared to $483
• The rapid rise caused short positions to be forcibly covered due to margin calls
• Media reported that shorts lost over $5 billion USD in this short squeeze
• One week later, the stock price plummeted over 80% again

Subsequently, WSB users continued to hype other heavily shorted stocks like AMC and Blackberry, making this one of the most extreme short squeeze operations in recent years.

Scenario Two: Fundamental Reversal — Natural Market Short Squeeze

Tesla is a typical example of this.

Before 2020, Tesla was praised as the leader in electric vehicles, but its sales volume was modest, and the company was losing money year after year. Many institutions shorted the stock — after all, a company with superficial strength will eventually reveal its true nature.

But the turning point came in 2020: Tesla turned profitable, with the Shanghai Gigafactory contributing explosive revenue. How did the stock move? In just half a year, it increased nearly 6 times, from $350 to $2,318. Later, the stock split (1-for-5), and within a year, the price broke through the 1,000 mark (highest at $1,243).

In just two years, the stock price increased nearly 20 times. Short sellers’ accounts were completely blown up.

This is a typical natural short squeeze caused by fundamental improvement. But essentially, it’s the same as GME — short investors lose everything.

What Signals Precede a Short Squeeze?

A short squeeze generally requires two preconditions:

1. Excessive Short Positions When the short interest exceeds 50% of the circulating shares, risks start to spike sharply. Any positive news can trigger a chain reaction.

2. Extremely High Market Attention GME is a childhood memory; Tesla is a future imagination. High attention means a continuous influx of new buyers, further pushing up the stock price.

How to Protect Yourself in the Era of Short Squeezes?

If you are a short seller, how can you survive?

First Rule: Monitor Short Interest Ratio

If short interest exceeds 50%, even if the stock is temporarily weak, you should decisively cover. Small gains or small losses are okay; staying alive is the priority.

Monitor two indicators:

• RSI between 50 and 80: Bullish market strength, easy to get squeezed
• RSI below 20: Oversold condition, market is irrational, and reversal risk is high

Once RSI drops below 20, it indicates the market is far from rational. Continuing to hold at this point is like gambling with your life.

Second Rule: Take Profits Ruthlessly

If you want to profit from a short squeeze, remember — the moment you cover your short is your exit signal. Because these buyers are not genuinely optimistic about the company; they just want to cover their previous short positions. Once covered, the stock will quickly fall back to a reasonable price.

Being greedy and holding on a bit longer may trap you at the top.

How to avoid the risks of short squeeze stocks?

1. Choose major indices or large-cap stocks

These assets have huge liquidity and are less likely to have excessive short interest. Shorting the market index is much safer than shorting individual stocks.

2. In a bear market, wait for a rebound before shorting

Don’t keep shorting at the bottom. Wait for a market rebound and bullish sentiment to re-enter, making risk more controllable.

3. Use CFDs or futures instead of borrowing stocks to short

Borrowing stocks can lead to forced covering. In contrast, CFD contracts allow you to control leverage more flexibly, reducing risk.

4. Ultimate defensive strategy — hedging

Buy stocks long while shorting the market index. If your allocation ratio is 1:1, as long as the stock outperforms the index or the stock declines less than the index, you profit. This way, you participate in the market and diversify risk.

Final Warning

Short selling is like robbing a bank; whether you succeed or not, safety first is key.

While paying attention to the order book movements of short squeeze stocks, you must also monitor changes in fundamentals and news. A single positive piece of news can ruin a short seller’s game.

Those who survive to laugh last are often not the biggest winners but the ones who make the fewest mistakes. In the game of short squeezes, caution always comes before greed.