The true meaning of "嘎空": Why does short selling face such risks?

In the investment market, “Short Squeeze” is a concept that investors must understand. Simply put, a short squeeze occurs when the price of a stock or asset rises, forcing short sellers to buy back the asset to cover their positions, which in turn drives the price even higher. This risk can cause unimaginable losses for those engaged in short selling.

The Core of Short Squeeze: How Rising Prices Force Shorts to Cover

A short squeeze involves a straightforward but fierce market logic. When investors short a stock, they borrow shares from long-term shareholders and sell them, expecting the price to fall so they can buy back cheaper and profit from the difference. But if the stock unexpectedly rises, short sellers face the risk of margin calls and are forced to buy back shares at higher prices to cover their positions, creating a short squeeze.

There are two common types of short squeezes:

One is a natural market rebound, where rapid price increases force short sellers to cover. The other is more dramatic—certain influential groups deliberately push up the stock price, causing retail short sellers to cover at high prices, profiting from their forced buybacks.

Regardless of the scenario, the core idea remains: The more shorts there are, the greater the price increase, as all short sellers scramble to escape.

Three Common Methods of Short Selling

To understand why a short squeeze occurs, first understand how investors execute short selling. Common methods include:

Borrowing shares to sell directly — Borrowing shares from long-term shareholders and paying interest, then buying back after the price drops to return the shares.

Using futures contracts — Shorting via futures, which requires margin deposits and rollover at expiration.

CFD contracts — Investors can adjust leverage freely, with no need to rollover, but still face forced liquidation risks.

No matter which method is used, if the stock price continues to rise, investors risk margin calls and forced liquidation by brokers. This explains why short selling offers limited upside (profit is capped at the stock dropping to zero) but unlimited risk (the stock can rise infinitely).

How a Short Squeeze Happens—Market Manipulation and Fundamental Changes

Classic Case 1: GME Event—Retail Investors Fight Back Against Wall Street

At the end of 2020, game retailer GME was in trouble. As mobile and PC gaming became dominant, physical game stores saw declining sales. Many Wall Street firms believed GME was severely overvalued and began shorting heavily.

In September 2020, Canadian entrepreneur Ryan Cohen bought large amounts of GME shares and joined the board, aiming to turn around the struggling company. The stock price rose from single digits to around $20. Wall Street institutions increased their short positions, with short interest exceeding 140% of the float.

This news exploded on Reddit’s WallStreetBets forum. Thousands of retail investors banded together to buy GME, aiming to force Wall Street’s shorts to “lose.”

The result was astonishing: on January 13, 2021, the stock surged 50% to $30, then skyrocketed to a peak of $483 within two weeks. Short sellers, facing margin calls, had to cover at high prices, further pushing the stock up, resulting in estimated losses exceeding $5 billion. After the short squeeze, the stock price plummeted over 80% within a week.

Subsequently, WSB communities continued to hype other heavily shorted stocks like AMC and BlackBerry, sparking waves of short squeezes.

Classic Case 2: Tesla—Fundamental Changes Trigger a Short Squeeze

Tesla’s story is different but also caused a massive short squeeze. As a leader in electric vehicles, Tesla had long reported losses. Many institutional investors believed the valuation was overblown and shorted heavily, making Tesla one of the most shorted stocks.

In 2020, a turning point arrived—Tesla turned profitable, with the Shanghai Gigafactory contributing significantly to revenue. The stock price soared from around $350 to $2,318 in just half a year, nearly a sixfold increase. The company also split its stock (1 for 5), and within a year, the price rose from over $400 to over $1,200, peaking at $1,243.

In just two years, Tesla’s stock price increased nearly 20 times. This short squeeze was driven not by manipulation but by genuine fundamental improvements attracting buying interest. Short investors faced huge losses and were forced to cover.

These cases show that a short squeeze can stem from both market manipulation and real fundamental shifts. In either case, short sellers often suffer significant losses.

How Investors Can Protect Themselves from Short Squeeze Risks

Short selling is like walking on a cliff—potentially lucrative but with the risk of a sudden fall. How can investors safeguard their capital when a short squeeze occurs?

Strategy 1: Beware of Excessive Short Interest

When short interest exceeds 50% of the float, the stock becomes a “target,” and the risk of a short squeeze rises sharply. Even if the stock is currently weak, it’s advisable to close short positions promptly. Small gains or losses are less important than safety.

Monitor these indicators:

• RSI (Relative Strength Index) — Between 50-80 indicates bullish momentum; 20-50 suggests bears still have an edge. An RSI below 20 signals oversold conditions, implying a potential reversal.

Strategy 2: If Participating in a Short Squeeze

Some investors consider riding the wave—can they profit from a short squeeze? Yes, but strict discipline is essential:

Keep an eye on short interest. As long as short interest continues to grow, the squeeze can persist. But once short interest starts to decline (short sellers buy back to cover), it’s a warning sign. At that point, take profits immediately, as the upward momentum is waning.

Remember: these buy-ins are often driven by forced covering, not genuine optimism. Once covering is complete, prices can fall sharply, with volatile swings.

Practical Tips to Avoid Falling Into a Short Squeeze Trap

To steer clear of the depths of a short squeeze, start with the right assets:

Prioritize large-cap indices or blue-chip stocks for shorting. These assets have high liquidity and broad participation, making extreme short interest less likely. Smaller-cap stocks are more vulnerable to targeted squeezes.

Avoid borrowing shares to short. Forced buy-ins can happen suddenly, leaving you powerless. Using CFDs (contracts for difference) offers more flexibility, allowing you to control leverage and manage risks better.

Implement hedging strategies: For example, go long on promising stocks while shorting the market index. If the stock rises faster than the index, you profit; if it falls less, you limit losses. This approach reduces the risk of being caught in a short squeeze.

Final Advice

Ultimately, a short squeeze boils down to: the profit ceiling for short sellers is low (stock drops to zero), but the potential losses are unlimited. When market sentiment is high and short interest is concentrated, prices can surge multiple times in a short period, trapping all short investors.

For short sellers, the priority isn’t maximizing gains but surviving. During volatile periods, stay vigilant about the company’s fundamentals and market news. A single major positive development can instantly wipe out carefully planned short positions, turning patience into losses.

Trade safely, think rationally—this is the ultimate rule for managing short squeeze risks.