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When a stock’s price starts to rise rapidly, short sellers want out, as they only profit when the stock goes down. They can face theoretically unlimited losses when shares rise. Their pain, however, can be a short squeezer’s gain.
Understanding Short Squeezes
Before you can understand short squeezes, you have to understand how short sellingS works.
If a short seller thinks a stock is overvalued and shares are likely to drop in price, he or she can borrow the stock through a margin account. The short seller will then sell the stock and hold onto the proceeds in the margin account as collateral. Eventually, the seller will have to buy back shares. If the stock’s price has dropped, the short seller makes money because he or she can cash in on the difference between the price of the stock sold on margin and the reduced stock price paid later. However, if the price goes up, the buyback price could rise beyond the original sale price, and the short seller will have to sell it...
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