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FX Lingo: The Short Squeeze

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FX Lingo: The Short Squeeze

[Post Date]      Barbara Rockefeller

The short squeeze occurs in all securities markets, not just FX. But short selling—selling the security today with a plan to buy it back later at a lower price—is far more prevalent in FX and commodities than in equities.

Let’s say the market takes a strong dislike to a currency. Sentiment is deeply negative. The price falls as holders exit and short-sellers enter in droves. The most notable example in recent years was the gigantic sell-off in the pound sterling on the Brexit vote news in June 2016.

At some point, chart indicators show the currency is oversold. Numerous indicators perform this function. The most popular may be the stochastic oscillator, although we know this is less effective and reliable in a heavily trended move. Others include

  • Previous historic low
  • Hand-drawn support line
  • Bollinger band, Average True Range band or linear regression channel
  • Ichimoku kumo

When a big market participant player or a handful of big players see the currency as wildly oversold, they want to lift the price to make the short-seller exit in order to sell again themselves. A short squeeze is a form of market manipulation—frightening the other short-sellers into covering their short sales by buying it back to close their positions. When the prices has risen enough to satisfy the squeezers, they come back with their own short sales at a more favorable level.

Like many other chart developments, the short squeeze is not a function of fundamentals. It is motivated solely by the positioning of the big players. We might even project that in a downward sloping trend, the many upside corrections/pullbacks are a minor form of the short squeeze.

 

Barbara Rockefeller

President + Author

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