Should we fear the short squeeze?
There’s nothing a bear loves more than shorting a bounce that quickly leads to a reversal into new lows. For many (myself included), that is the game plan for swing trades in a downtrend: get short on the reversions to the mean.
While this is certainly a strategy that has merit, there’s always one thing the bears fear most looming in the distance: the short squeeze.
When the market reaches oversold readings and too many market participants are leaning short, the potential for a short-squeeze is always around the corner. In fact, you’ll see some of the biggest/rapid moves to the upside in a downtrend, all as a result of the market trapping shorts and squeezing them.
For those who have been short during a short squeeze, we know it can be an unpleasant experience. While it can be uncomfortable taking heat against our open positions, there’s a few adjustments you can make to put yourself (and your shorts) in a position to remain comfortable.
Here are my tips for handling “the short squeeze heat”
- Get short into bounces, NOT when the market is deeply oversold. I look to get short near the daily 21 exponential moving average (EMA).
- Give your trades more time time till expiration. While short squeezes can be violent, they tend to be short-lived. Giving your trade more time till expiration will make it easier to sit through those rips.
- Sell call credit spreads. Selling out-of-the-money credit spreads with 30 to 60 days till expiration is a great way to get positioned for a bigger picture move lower, while still being able to sit through the ebbs and flows. So long as the market closes under your short strike at expiration, there’s a paycheck with your name on it.
So don’t fear the short squeeze! Instead, make adjustments that put you in a better position to stay confident in your trades during large bounces.
Stay Focused!