when identifying stocks at risk of a short squeeze two useful measures are short interest and the short interest ratio 
short interest is the total number of shares sold short as a percentage of the total shares outstanding the short interest ratio is the total number of shares sold short divided by the stock s average daily trading volume speculative stocks tend to have higher short interest than more stable companies watching short interest can tell you whether investor sentiment about a company is changing for example if a stock typically has a 15 to 30 short interest a move above or below that range could signal that investors have shifted their view of the company fewer short shares could mean that the price has risen too high too quickly or that the short sellers are leaving the stock because it has become too stable a rise in short interest above the norm indicates that investors have become more bearish but an extremely high reading could be a sign of a coming short squeeze which could force the price higher contrarian investors may buy stocks with heavy short interest to exploit the potential for a short squeeze a rapid rise in the stock price is attractive but it is not without risks the stock may be heavily shorted for good reason such as a dismal future outlook active traders will monitor highly shorted stocks and watch for them to start rising if the price begins to pick up momentum the trader jumps in to buy trying to catch what could be a short squeeze and a significant move higher there are many examples of stocks that moved higher after they had a heavy short interest but there are also many heavily shorted stocks that then keep falling in price a heavy short interest does not mean that the price will rise it means that many people believe it will fall anyone who buys in hopes of a short squeeze should have other and better reasons to think that the price of the stock will go higher naked short selling vs short squeezenaked short selling is short selling a stock without first borrowing the asset from someone else it s the practice of selling short shares that have not been affirmatively determined to exist per the u s securities and exchange commission sec abusive naked short selling is illegal 3naked shorting still happens thanks to discrepancies between electronic and paper trading naked shorting can help exacerbate short squeezes by allowing for additional shorting that otherwise might not exist naked short selling is said to help balance the market that is naked shorting can force a price drop which leads to some share sales to cut losses allowing the market to effectively find balance example of a short squeezeconsider a hypothetical biotech company xyz which has a drug candidate in advanced clinical trials there is considerable skepticism among investors about whether this drug will actually work as a result there is heavy short interest in fact 5 million xyz shares have been sold short of its 25 million shares outstanding this means that the short interest in xyz is 20 and with daily trading volume averaging one million shares the short interest ratio is five the short interest ratio also called days to cover means that it will take five days for short sellers to buy back all xyz shares that have been sold short assume that because of the huge short interest xyz shares had declined from 15 a few months ago to 5 then the news comes out that xyz s drug works better than expected xyz s shares jump to 9 as speculators buy the stock and short sellers scramble to cover their short positions everyone who shorted the stock between 9 and 5 is now in a losing position those who sold short near 5 are facing the biggest losses and will be frantically looking to get out because they are losing 80 of their investment the stock opens at 9 but it will continue to rally for the next several days as the shorts continue to cover their positions and the rising price and positive news attract new buyers real world example gamestop short squeezea notable short squeeze occurred among traders and investors of gamestop corp gme during the months following the covid 19 pandemic with consumers locked down and stores often closed analysts and investors expected the company to potentially face bankruptcy because of a rise in competition and a decline in foot traffic at brick and mortar stores gme became a favorite target of short sellers the short interest had grown so dramatically that it amounted to more than 100 of the shares outstanding 4that led scion asset management s michael burry to develop a bull case for the company that it could return to profit in a couple of years instead of going bankrupt his thesis was published and repeated by reddit and youtube content creators midway through 2020 michael burry and chewy co founder ryan cohen also took a long position 5enough investors started buying the stock late in 2020 and the share price began to rise noticeably late in 2020 from there it was a snowball effect of retail investors buying stock and call options the price increase drove out some short sellers and attracted various big name investors and public figures such as elon musk and venture capitalist chamath palihapitiya 5gamestop s stock price surged due to a short squeeze on major hedge funds that were short the stock and forced to sell to cut losses the stock price went from less than 5 a share to 120 in just a month 64after the initial meme stock craze gamestop shares drifted steadily lower settling at just over 10 a share by the spring of 2024 however in mid may of that year the stock suddenly skyrocketed once again after keith gill also known as roaring kitty resurfaced on social media after a three year hiatus gill s cryptic posts on the platform x formerly twitter reignited interest in gamestop as well as other meme stocks leading to a massive surge in trading volume and price gamestop shares rose nearly 100 on tuesday may 14 2024 following a 74 increase the previous day 7 this sudden rally caught many investors and analysts by surprise as the company s fundamentals had not significantly improved since the initial meme stock frenzy in 2021 the resurgence of meme stocks in 2024 once again put pressure on short sellers who had re established bets against gme and other meme companies according to analytics firm s3 partners gamestop short sellers lost over 1 3 billion in the initial may 2024 squeeze with more losses on the horizon if the stock continues to pump 8while the renewed 2024 meme stock rally shared many similarities with the 2021 event some analysts questioned whether it would have the same lasting impact on the market and retail investor participation nonetheless the sudden resurgence of these stocks served as a reminder of the power of social media and retail investor sentiment in driving market trends 7