Topic: Beware of supply squeezes (Read 160 times)

I bet many of you are well aware of what is called short squeezes. In case you didn't know, a short squeeze is a quick rise in price, mostly artificial in nature. Being that, it is primarily aimed at making short sellers cover their positions at a loss or cause a margin call followed by a forced liquidation of those positions by an exchange itself. Basically, it is why naked shorts can be fatal to your trading balance

Now that you are familiar with short squeezes, it is time to learn about a new beast - supply squeezes. As the name suggests, they happen when there is a lack of supply, and this is what seems to happen these days. You may ask why they are ever possible at these prices and how they are conceptually different from short squeezes. In fact, this is a very important distinction for us and our trading careers to see and understand

As I already said, short squeezes are artificial and they typically happen in a truly bear market, i.e. in an environment which can be considered natural or genuine. Supply squeezes, on the other hand, are opposite to short squeezes in the sense they are themselves quite natural and genuine, i.e. caused by limited supply rather than direct manipulation, but they are made possible by and happen in an environment which itself is artificial

When the price goes very low, the supply of a limited asset necessarily runs dry as people are no longer willing to sell at such prices (provided the asset itself is genuine and offers real utility, of course). But the prices may still not rise as there might not be enough demand, either. So both supply and demand become thin and that causes volatility to build up, which consequently leads to severe price swings

Essentially, it is the same thing which happens when the price is too high as both extremely high and extremely low prices lead to insane volatility. I was talking about it in early December, 2017, when we were heading to all time highs, and now we basically see the same pattern as we near bottom. This is somewhat counterintuitive but it is how the market behaves at its extremes