Long Squeeze: What it is, How it Works, Example

What Is a Long Squeeze?

A long squeeze occurs when a sudden drop in the price of a stock or other asset incites further selling. In a long squeeze, long holders of a stock are pressured into selling their shares to protect against a dramatic loss.

Understanding Long Squeezes

Long squeeze can be contrasted with the more well-known short squeeze. Long squeezes are more apt to be found in illiquid stocks, where a few determined or panicky shareholders can create unwarranted price volatility in a short period of time.

Short sellers can monopolize the trading in a stock for a brief period of time, creating a sudden drop in price. Yet a long squeeze requires enough panic to set in that long holders start to dump their positions as well. A long squeeze, which has no fundamental basis for the selling, may last for some time, or it may be very brief. Value-buyers or short-term traders who watch for oversold conditions will step in once the price falls to a point deemed "too low," and bid the shares back up.

Long squeezes can occur in any market but may appear more dramatic in low liquidity markets. While liquidity plays a role, so do technical factors and supply and demand. A stock that has been running aggressively higher becomes more and more susceptible to a long squeeze, especially if the volume is very high when the price turns lower. All those people who bought near the top will start exiting in droves if the price declines significantly. Many simply cannot afford to hang onto the loss even if they think the price will get back to current levels, or higher, after the decline.

Value-oriented investors and value investing styles have long been the classic remedy to securities that have been oversold. Recognizing a long squeeze scenario, value and deep-value investors are generally quick to react to stocks that may be trading at discounts to their true intrinsic value. If a stock doesn't recover from its decline, then there was likely a fundamental reason for the sell-off or the stock was overpriced, to begin with. In this case, the selling was reasonable and justified and is not typically considered a long squeeze.

When long squeeze situations arise, they are generally concentrated in stocks that have a limited float or market capitalization, or at least the selloffs in these types of stock can be quite dramatic. These small or even micro-cap securities do not always enjoy 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 exploit a long squeeze before others bring the stock back from its oversold state.

A stock's float is measured by its number of shares actually available for trading, as some securities are held in treasury or by insiders. Stocks with limited float make for natural squeezes from the long or short side. In these types of stocks, fewer participants control the shares and thus the share price. A large sell order from a big trader can cause a cascade of selling. Compare that to a highly liquid stock with millions of shareholders, and millions more that are actively interested in buying the stock, and any long squeezes that do occur tend to be less severe.

Long Squeeze Example

Intraday charts frequently show long squeezes. This is because during most days there is no new fundamental news about the company, and on many days there is not even news about the economy. Therefore, when there is no major news out that could affect the fundamental value of a stock, the price will still fluctuate as people buy and sell.

Day traders need to get into and out of a stock within the day. Therefore, if the price is rising, and they enter long, they will sell if the price starts to fall by too much. Their timeframe is too small to hold onto a falling stock.

Consider this 1-minute intraday chart of Apple (AAPL). The price is always moving, and with no fundamental data to cause the selloffs, the selloffs that do occur are caused by short-term longs being forced to sell as the price starts to fall.

The long squeezes were quickly met with buying, showing that it was panicked long holders taking profits and cutting losses who caused the declines, and not a fundamental shift in the value of the company.