You’re thinking about short squeezes all wrong

Amid the return of many, many meme-stock-esque market conniptions this week, I think we need to change the way we think about short squeezes.

One of the reasons why certain stocks become meme stocks is because they have an elevated share of short interest. This, to my mind, is for two reasons:

• When you’re buying a stock without much in the way of a fundamental catalyst, it helps to have a ready-made candidate who “has” to buy from you at a higher price.

• It creates an “us against them” mentality that’s useful in forming and binding together a group of committed buyers on internet forums.

(If we’re assuming every stock buyer is then directly registering their shares to remove them from the pool of potential borrowers, sure, that’s a different potential angle. I have not seen ample evidence of this dynamic occurring en masse recently, but I can’t rule it out.)

What is striking about some of these massive rallies in stocks is the magnitude of the explosion in flows. Kohl’s traded over 200 million shares on Tuesday. Opendoor Technologies traded nearly 1.9 billion on Monday.

This raises a thorny point: not everyone who’s buying can sell to a short seller. The more volumes get plowed into a stock by different enthusiastic buyers, the more likely (read: certain) it is that many of them become reliant on a similarly minded “greater fool” to profit, not forcing a short seller to take their ball and go home. 

Let’s turn back to Kohl’s. On Tuesday, volumes were over 200 million. As of the end of June, a little over 53 million shares were sold short.

Hypothesize a world where short interest went completely to zero that session. Definitionally, that means short sellers closing their positions would have amounted to only about one-quarter of the volume. In all likelihood, that didn’t happen. It’s just a greater number of traders making money off other traders waiting to make money off shorts.

Looking at the “DORK” stocks, as my colleague David Crowther dubbed them (adding Krispy Kreme and Rocket Companies to complete the quartet with Opendoor and Kohl’s), you can see how much buying power, rather than giving-up-on-selling-short power, reigns supreme.

I looked at how much volume rose during each stock’s highest-volume day compared to their monthly average at the end of Q2, then divided that by the number of shares sold short at the end of Q2, per exchange data.

Loosely, think of that as, “How many times could the entire short position have gone to zero that day based on the increase in volumes alone?” Then, I looked at the weekly return for each stock at its peak, as of 2:40 p.m. ET on Thursday.

The results are pretty stark, especially at the extremes of these already extreme examples:

Rocket Labs has by far the most boring chart of all of these this week, and the net increase in volumes relative to its average wouldn’t have even been enough to send short interest to zero on Thursday. On the other hand, the extra volume in Opendoor on Monday was enough for that to have gone to nothing 13 times over.

Many events that we might colloquially refer to as “short squeezes” are buyer’s binges (and, in the event that much of the activity is taking place through bullish bets in the options market, gamma squeezes).

Short squeezes are really just the friends you made buying along the way — who unavoidably become part of your exit strategy.