An A — Z Guide on How to Trade the Squeeze
How to get a lot of juice when a squeeze occurs? Check out this blog to learn everything you need about how to trade the squeeze to exploit them effectively.
A single squeeze can cause a huge loss. For example, back in January 2021, the GameStop short squeeze caused short sellers to lose $5.05 billion. Therefore, it is important to learn about trading the squeeze to minimize your loss and maximize your profit potential.
With this blog, you will learn how to trade the squeeze in great detail. It will give you an in-depth look into squeezes so you can be confident to exploit them effectively to level up your trading.
What Is the Squeeze in Trading?
Squeeze trading is used to describe several financial and business situations that involve some sort of market pressure. In business, it is a period when it is difficult to borrow or a time when profits decline due to increasing costs or decreasing revenues.
In the financial world, it is used to describe situations wherein short sellers buy stock to cover losses or when investors sell long positions to take capital gains off the table.
When a squeeze occurs, investors often feel “squeezed” and have a tendency to make changes in their stock positions that they hadn’t planned. The change in investors’ buying activity often causes an increase in a stock’s price.
Squeeze situations often go hand in hand with feedback loops that can make a bad situation worse. Understanding what it is and its different types will help you learn how to trade the squeeze better.
How to Trade the TTM Squeeze Indicator?
For many new traders, one of the most difficult concepts to grasp is to understand momentum and the direction of the price at support and resistance levels.
In order to set yourself apart from the average traders to earn a maximal profit, you should be able to spot momentum increasing or waning at these levels.
There is a large number of indicators on the charts of many today, but in this blog, we would like to spotlight one which is growing in popularity; the BB/KC Squeeze Indicator, also known as the TTM Squeeze Indicator.
The TTM Squeeze Indicator is a volatility and momentum indicator used to visualize the relationship between the Bollinger Bands® and Keltner Channels in order to identify when an asset is consolidating (squeezing) and signals when prices are poised to break out/down.
This game-changing tool is designed to recognize when periods of volatility are about to occur, which offers improved profitability with a good understanding of how it works.
When calculating, you need to pay attention to two components of the TTM Squeeze indicator: The Squeeze on/off dots and the momentum histogram.
The Squeeze on/off dots signal when volatility conditions are right to buy while the momentum histogram helps to determine the direction (long or short) in which to trade.
The squeeze dots turn red when volatility levels are low. And when volatility rises and the Bollinger Bands expand until they are outside of the Keltner Channels, the squeeze has “fired” and the squeeze dots turn green.
Traders are recommended to buy on the first green dot after one or more red dots.
How to Trade the Bollinger Squeeze in a Sideways Market?
Every trader has heard of John Bollinger and his namesake bands. Although Bollinger Bands® are some of the most useful technical indicators used on charting programs, they are also among the least understood.
In order to stay ahead of the game, you should read the book “Bollinger on Bollinger Bands®,” to fully understand how the bands function.
Bollinger Bands® is used to identify a stock’s high and low volatility points. Although future prices and price cycles are difficult to forecast, volatility changes and cycles are relatively easy to identify.
The reason lies in the fact that equities alternate between periods of low volatility and high volatility, much like the calm before the storm and the inevitable activity afterward.
Take a look at the Squeeze equation:
BBW = TBP — BBP/SMAC
BBW = BollingerBand® width
TBP = Top BollingerBand® (the top 20 periods)
BBP = Bottom BollingerBand® (the bottom 20 periods)
SMAC = Simple moving average close (the middle 20 periods)
The volatility is high when Bollinger Bands® are far apart. On the contrary, the volatility is low when they are close together. When volatility reaches a six-month low and is identified when Bollinger Bands® reaches a six-month minimum distance apart, a squeeze is triggered.
How to Trade the Short Squeeze?
Short squeezers gain profits when a stock’s price starts to rise rapidly. When this situation happens, short sellers want out, because they only profit when the stock goes down. When shares rise, unlimited losses are for them while the gain is for short squeezers.
To trade the short squeeze, you will need to understand how short selling works. Short sellers borrow the stock through a margin account when they think a stock is overvalued and shares are likely to drop in price.
They will then sell the stock and hold onto the proceeds in the margin account as collateral. In the end, the seller will have to buy back shares. If there is a decrease in the stock’s price, the short seller makes money due to the difference between the price of the stock sold on margin and the reduced stock price paid later.
However, if there is an increase in the price, the buyback price could rise beyond the original sale price, and the short seller will have to sell it quickly to avoid even greater losses.
In order to trade the short squeeze, you should be able to predict it. This requires you to interpret daily moving average charts and calculate the short interest percentage and the short-interest ratio.
The higher the short interest percentage is, the shorter sellers there will be competing against each other to buy the stock back if its price starts to rise. You should try to trade a potential short squeeze when a short interest ratio of five or better.
How to Trade the Long Squeeze?
A long squeeze is less known than a short squeeze. Long squeezes are more highly likely to be found in illiquid stocks, where a few determined or panicky shareholders can create unwarranted price volatility in a short period of time.
A sudden drop in price can occur as short sellers can monopolize the trading in a stock for a brief period of time. However, a long squeeze requires enough panic to set in that long holders start to give up on their positions as well.
A long squeeze, which has no fundamental basis for the selling, can be brief or last for some time. When the price falls to a point deemed “too low,” value-buyers or short-term traders who watch for oversold conditions will step in and bid the shares back up.
Long squeezes happen in any market; however, they appear more dramatic in low liquidity markets. A long squeeze is more highly likely to happen to a stock that has been running aggressively higher, especially if the volume is very high when the price turns lower.
All the buyers who purchased near the top will start exiting in droves if the price declines significantly. Many traders simply cannot afford to hang onto the loss even when they think the price will bounce back to current levels, or higher, after the decline.
These small or even micro-cap securities might not have a healthy level of liquidity that can support price levels from irregular trading volumes.
A quick trader or automated trading system can jump on an opportunity to take advantage of a long squeeze before others bring the stock back from its oversold state.
We can measure a stock’s float by the number of shares available for trading, as some securities are held in treasury or by insiders. Stocks that have a limited float make for natural squeezes from the long or short side.
In these types of stocks, not many participants control the shares and thus the share price. Therefore, a large sell order from a big trader can lead to a cascade of selling. Compare that to a highly liquid stock that has millions of shareholders, and millions more that are actively interested in buying it, and any long squeezes that do occur tend to be less severe.
Different Types of Squeezes
There are multiple types of squeezes such as profit squeezes, credit squeezes, short squeezes long squeezes, and bear squeezes. Take a closer look at each type to know how to trade the squeeze better.
Profit Squeeze
A profit squeeze is realized by a business when its profit margins go down. This type of squeeze occurs due to falling prices, rising costs, increased competition, changing governmental regulations, or expanding producer and supplier power.
Credit Squeeze
A credit squeeze (also known as a credit squeeze, credit tightening, or credit crisis) refers to a decline in lending activity by financial institutions brought on by a sudden shortage of funds. This type of squeeze normally occurs amid a recession or when interest rates are rising.
The issuance of bad debt, such as in the case of the 2008 financial crisis, often leads to a recession and a credit squeeze. Normally, rising interest rates occur when the Federal Reserve deems the economy is strong enough, and consumer confidence is high enough, to assume a higher rate of interest.
Short Squeeze
A short squeeze is a common scenario in the equities market when a stock moves sharply higher, prompting traders who bet its price would fall to buy it to avoid greater losses.
When an investor bets the price declines in the short term, he will short a stock. If the opposite occurs, going long by purchasing shares of the stock is the only way to close the position.
This leads to a further increase in the stock’s price, resulting in further action by short sellers.
Long Squeeze
A long squeeze occurs in a strong financial market when investors, who hold long positions, feel the need to sell into a falling market to cut their losses thereby creating a cycle.
This type of squeeze normally occurs because investors place a stop-loss order to mitigate risk and ensure they are protected against any price declines.
Bear Squeeze
A bear squeeze refers to a sudden change in market conditions that force traders, attempting to profit from price declines, to buy back underlying assets at a higher price than they sold for when entering the trade.
When a bear squeeze happens, traders get squeezed out of their positions, usually at a loss. This type of squeeze can be brought about by intentional events, such as an announcement by a central bank, or a byproduct of market psychology.
A Gamma Squeeze
A gamma squeeze is often linked to options trading. This type of squeeze occurs when the underlying stock’s price begins to go up very quickly within a short period, forcing investors to change their stock positions. This squeeze might cause a large spike in the share price.
Other Types of Squeezes
There are many other types of squeezes that we cannot go into detail about in this blog. Here are some for you to explore if you want to understand more about squeezes: a liquidity squeeze, a financing squeeze, etc.
Conclusion
Understanding the different types of squeezes will help you, master, and trade the squeeze. For more information on how to trade the squeeze, you can also check out this course The Squeeze Pro System (Pro) — John F. Carter.
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