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The whole Gamestop debacle has proved how profitable short squeezes can be. It essentially allows you to pressure large hedge funds who shorted too hard. So I was wondering, why aren't there already automated systems in place by other funds that monitor the short interest of different stocks and look for opportunities to capitalise on it. Here's how I imagine it:

  • Look for stocks that have a short interest higher than 50%
  • automatically buy at least 50% of the float that stock
  • refuse to sell under any circumstances and just wait for the price to rise

Is there a reason this wouldn't work?

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The reason this doesn't work is because of the real world: a failing company can declare bankruptcy, which they would declare to protect themselves from creditors, the creditors would be bondholders who have a contractual claim to money from revenue and assets, and the bankruptcy overrides the contract and lets a judge re-sort the claims.

Shareholders are behind bondholders, and usually get nothing, so the shares would be worth $0.00000 so it is completely rational to short a failing company that has no source of revenue or capital, because you deliver the shares back to their original owner at $0.00000 in the future, and you keep the difference from the price you borrowed and sold them at, and $0.00000 which is always a 100% delta, and if you yourself are leveraged then it is a 100% delta * leverage.

This works most of the time. The death spiral is real. Such automated systems exist but the same people running them also don't want to be stuck with illiquid shares.

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    So a proper short squeeze only works when the company behind the stocks isn't actually failing? Seams like all you need is to figure that out on a case by case basis and the system could work Feb 1 at 9:08
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    @user2741831 there are fundamental investors and activist investors that have this as their entire market strategy, but yes, the opposite of automated. Many short sellers can easily hedge their bets to the upside, making a squeeze unlikely just because the price moved against the short bet. The primary way to squeeze the shorts is to coordinate that every shareholder requests their shares back, aka turning off the borrow. This level of coordinated market action is legal.
    – CQM
    Feb 1 at 14:42
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    But it seems to me that the response to over-shorting GameStop (and perhaps other companies) is entirely unrelated to the inherent value of the company. Sure, management & board members who held blocks of stock acquired at the older, realistic valuation are now quite wealthy (assuming they sold near the high), but when the frenzy's over, GameStop will go back to being a gradually failing business.
    – jamesqf
    Feb 1 at 17:56
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    @jamesqf DFV had been saying since Q3 2018 that he believed GameStop's fundamentals were sound, with analysis. Feb 1 at 21:16
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    @chrylis -cautiouslyoptimistic: Yeah, and there are a bunch of people who apparently believed that Trump won the election, and were willing to act on that belief. People are capable of believing all sorts of things that have no discernable connection to objective reality.
    – jamesqf
    Feb 2 at 2:54
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I think this question makes false assumptions that are prevalent at the moment in the WSB rhetoric and echoed in the media. The claim that short squeeze "allows you to blackmail large hedge funds who shorted too hard", is not only sloppy/inaccurate (it can help you win a trade, not "blackmail" anyone?), but the over-the-top valence of the phrasing is indicative of making too much out of what happened. Newbie traders who just "discovered" what a short squeeze is a week ago, are explaining it like it's some genius hack they invented. On the contrary it's a well known, common thing.

Hedge funds are playing football against each other all the time, that's what they are all about. When X finds an angle, like Y and Z are over leveraged in shorts (as one example), X would try this same move on them, and then they'd play chicken on who can move the market. This is business as usual.

Every hedge fund (and individual trader) has different (proprietary) strategies for looking for different kinds of opportunities in the market. A short squeeze is one of many, and certainly there are already many firms that incorporate it into their filters and likely many of them have automated systems to look for those opportunities. So the premise of the question is wrong, there are people looking for this. That's not to say finding someone with a lot of shorts is an automatic good opportunity, further analysis is required (see other answers).

So there is nothing new or unique about this, despite how cool WSB people feel for participating in it. The only difference here is the "new hedgefund" WSB is chaotic neutral, and the rules of engagement (of stock chicken) are thrown out of wack. For example normally players in an instrument know who is interested in that instrument and how deep their pockets are, who they are playing against. They are not expecting a herd of retailers willing to endlessly buy something with no exit strategy. There is always irrational money but usually it is not coordinated and lost in signal/noise. They are expecting to play against rational agents who have an interest in protecting their capital and thus expect their opponents to play in predictable ways that allow for situational analysis. But the people buying this are (excuse the analogy) basically financial suicide bombers, most of them will lose what they put in buying higher and higher at prices that are over inflated (because they themselves are deliberately over inflating it). While a handful who bought in early and take profit early will make a killing, the rest will lose what they put in. And at least on the surface of their rhetoric, they are fine with losing their money (to early WSB people and hedgefunds B-Z) if it means hurting hedgefund A. Even still, as odd of a situation as that is, there's an adage for it: "the market can remain irrational longer than you can stay solvent". This was hedgefund A's mistake, believing that they could handle what they assumed would be a small amount of irrational money, and underestimating how much capital would come from viral memes on reddit, they doubled down, and lost.

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    I too think this is a good high-level summary but I think it would be helpful to elaborate on what exactly made it work in this situation. In other words, what is missing from the OP's scheme? I don't see this in other answers, just hand-waving "it's not that simple" kinds of answers. One relevant factor seems to be the combination of a short-squeeze and a gamma-squeeze. The other thing I'm puzzled about here is why didn't any hedge funds execute a similar move. Blackrock hold/held 13% of GME, for example.
    – JimmyJames
    Feb 1 at 22:19
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    OP is asking "why don't people/funds apply this strategy in every scenario", the only possible answer for that is "it's complicated, it depends on each scenario". As for why no one did it earlier in this scenario, I can only speculate the amount of capital needed, and the length of time they might have had to tie it up, didn't look great in a risk analysis. "Refuse to sell under any circumstance and wait for price to rise" is not sane professional risk management. You can say this to chaotic neutral redditors throwing money at lols, but not investors in your fund. I'm just guessing though. Feb 1 at 22:54
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    And lost? Did I miss something? Did they go bankrupt already?
    – user253751
    Feb 2 at 9:45
  • Great answer through and through, really covers well both the actual value play going on, as well as the irrational aspect that does not really capitalize on that value. Feb 2 at 14:05
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    No need to excuse the WSB == financial suicide bombers analogy, it's perfect. I'd upvote for that alone.
    – jamesqf
    Feb 2 at 16:54
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As an analogy, how does share price rise (or fall)? If there is an excess of buying volume that takes out all of the selling volume at current price, price moves up to the next order on the order book. The greater the buying volume and the more times this occurs, the larger the share price increase. OTOH, if a large buy order comes in and is met with a similarly large amount of sell side orders, share price goes nowhere.

Now suppose you find a stock where the short interest is higher than 50% and you and others attempt to buy at least 50% of the float. If opposing shorters sell an equivalent amount, price goes nowhere and your cabal has a lot of money invested as well as a lot of money at risk. What happens if instead, someone with deeper pockets decides to meet your buying with more shorting volume than you have bought? Rut oh.

The point is that it's not that simple or riskless to just find a heavily shorted stock and buy shares in order to create a short squeeze and thereby profit.

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  • So are you say the solution for a short position in a over-shorted stock is to short more? The hedge-funds clearly have 'deep pockets', why didn't they do that?
    – JimmyJames
    Feb 1 at 19:21
  • @JimmyJames: Shorting to solve being over-shorted is a kind of cross between martingale betting and chicken.
    – Brian
    Feb 1 at 23:09
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    @JimmyJames they may very well have done that, it's commonly termed "doubling down". If you think being short is a good trade, then you may very well decide getting shorter as it rallies is an even better trade. On the other hand some of the short funds may have closed out early, maybe even got long for a while and intend to get short again at much higher levels. Only time will tell who made the correct call(s) - clearly we're aware of a couple who didn't. Feb 2 at 1:08
  • This answer seems flawed. Unlike writing options, shortselling requires an availability of shares to borrow. And even if those are available, they can come at a cost. IIRC, for GameStop that price went up to a dollar per day. Remember, that's a fee paid by the shortsellers to those in long positions. If you short-sold GameStop at $20, you have 40 days for GameStop to file bankruptcy.
    – MSalters
    Feb 2 at 8:04
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    @MSalters - Your understanding of the borrow fee is totally wrong. A $20 short generates a $2,000 credit. If the borrow rate is 0.50 that is annual percent not dollars. The borrow rate for $2,000 is $2.74 per day ($2,000 * .50 / 365). Based on your incorrect concept of postulating how long you could keep a short position open, though it is not possible, if the share price remained at a constant price of $20 and the borrow rate did not change, you could keep the short position open for two years (50% ?). The reason that shorts cannot be maintained is the margin requirement not the borrow fee. Feb 2 at 14:11
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"Is there a reason this wouldn't work?"

Yes; there is nothing magical about 100%.

Let's imagine a company with a float of 100 shares. Investor1 through Investor6 each lends 10 stocks to shortSeller1 through shortSeller6, who sells that stock on. The short to float ratio is now 60%.

You come along and buy 50 shares, intending to hold to push the price up. There is 50 shares left floating. shortSeller1 covers his position buy buying 10 stocks and returning them to investor1. - Investor1 has no particular desire to keep the stock long term so there is still 50 shares left floating.

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