how does short covering work 
short covering is necessary in order to close an open short position a short position will be profitable if it is covered at a lower price than the initial transaction it will incur a loss if it is covered at a higher price than the initial transaction when there is a great deal of short covering occurring in a security it may result in a short squeeze wherein short sellers are forced to liquidate positions at progressively higher prices as they lose money and their brokers invoke margin calls short covering can also occur involuntarily when a stock with very high short interest is subjected to a buy in this term refers to the closing of a short position by a broker dealer when the stock is extremely difficult to borrow and lenders are demanding it back oftentimes this occurs in stocks that are less liquid with fewer shareholders monitoring short interestthe higher the short interest and short interest ratio sir the greater the risk that short covering may occur in a disorderly fashion 2 short covering is generally responsible for the initial stages of a rally after a prolonged bear market or a protracted decline in a stock or other security short sellers usually have shorter term holding periods than investors with long positions due to the risk of runaway losses in a strong uptrend as a result short sellers are generally quick to cover short sales on signs of a turnaround in market sentiment or a security s bad fortunes example of short coveringto close out a short position traders need to buy back the shares referred to as short covering and return them to the stock lender consider that xyz has 50 million shares outstanding 10 million shares sold short and an average daily trading volume adtv of 1 million shares xyz has a short interest of 20 and a sir of 10 both of which are quite high suggesting that short covering could be difficult xyz loses ground over several weeks spurring traders to open short positions in the stock one morning before they open the company announces a major upward revision in quarterly earnings xyz gaps higher at the opening bell placing traders positions into a significant loss some decide to wait for a more favorable price and hold off on covering while other short sellers exit their positions aggressively this disorderly short covering causes a sharp spike in the xyz share price creating a feedback loop that continues until the short squeeze exhausts itself traders who delayed short covering risk having to buy back the shares at a higher and higher prices exposing themselves to greater risk the gamestop short squeezea short squeeze occurs when investors who have shorted a stock or borrowed shares to sell with the expectation of buying them back at a lower price are forced to buy back those shares at a higher price to limit their losses it leads to a sudden surge in demand for the stock causing investors to buy back shares quickly driving the price even higher a meme stock buying frenzy in january 2021 led to a short squeeze in brick and mortar video game retailer gamestop causing several hedge funds to suffer significant losses 3as a result of the shift to online gaming and declining sales several prominent funds had built a large short position in gamestop retail traders noticed this high level of short interest in the stock and worked together through reddit trading group wallstreetbets to drive up the stock price by buying shares and options contracts as more investors piled into gamestop the stock price began to climb rapidly causing some of the hedge funds with short positions to suffer steep losses in an attempt to reduce risk some of these funds began buying back shares at a much higher price than they had initially sold them for to protect against a further rising prices institutional investors lost roughly 19 billion short selling gamestop in january 2021 according to data cited by business insider 4the squeeze was exacerbated by several hedge funds shorting more shares than the available float of shares in the market making it nearly impossible to cover all their short positions 5 this added immense pressure to buy back shares at any available price further pushing up the stock price the frenzied buying by retailer traders resulted in short covering by institutional investors creating a feedback loop that kept pushing gamestop shares higher ultimately the squeeze caused some hedge funds to lose billions of dollars and the stock price to rise from around 20 per share to over 400 in just a few weeks 