What also happens is new buyers are alerted when prices start to move which even further magnifies the buying and could cause a stock to go parabolic.
A good example of this was Dryships ($DRYS) that ran up over 2,000% following the news that Trump won the election.
This stock was heavily shorted but with the surprise win, shares were back in favor and buyers drove the stock up causing shorts to cover and the stock to shoot up. Shares were trading below $5 per share but over the span of just 4 day, shares breached $100 per share!
Here is an example of a short squeeze: In midst of the 2008 financial crisis something unexpected happened. German automaker Volkswagen was almost heading for bankruptcy but ended up becoming the world’s most valuable company for one, brief day.
Back then, investors and hedge including Elliott Management Corp and D.E. Shaw had shorted Volkswagen shares. However, these investors were not aware that Porsche SE had been quietly buying almost all freely traded ordinary Volkswagen shares in an attempt to take over the company.
In March 2008, Porsche SE denied claims that it planned to take over Volkswagen. Several months later the company disclosed it owned 42.6% of Volkswagen freely traded shares as well as controlling another 31.5% through financial instruments.
Then came the squeeze. When Porsche disclosed it had amassed control of roughly 75% of the shares in Volkswagen, short covering reached proper squeeze level, pushing Volkswagen shares from a low just above €200 on Oct. 19 to an absolute peak of €1,005 on Oct. 23.
This short squeeze briefly made the Wolfsburg-based automaker to become the most valuable company in the world, worth more by market capitalization than Exxon Mobil.
Investors and hedge funds that had shorted the stock were caught off guard and suffered massive losses, and some ended up taking legal action against Porsche SE.
The sudden news, combined with a large number of short positions and a very small float, caused the stock to skyrocket within a short period as investors desperately tried to cover their positions.
“It was one of the most painful days in my career,” Arndt Ellinghorst, then at Credit Suisse, but now a Senior Managing Director at Evercore ISI says, according to the Financial Times. “The pain among investors was unparalleled versus any other market scenario I have encountered.”
Another good example of a short-squeeze is Tesla (NASDAQ: TSLA), which has squeezed traders by a year-long bull run that has lifted the stock from $224 last year to above $1,800 as demand for its electric vehicles continues to improve.
Tesla has been a target of short-sellers, but the stock has recorded huge gains, prompting the company to issue a 5-for-1 stock split. For months, short-sellers have lost billions at the hands of the Elon Musk-led company.