DEFINITION of 'Cushion Theory'
The theory used when many investors have taken a short position in a stock. It is based on the idea that the price of the stock must eventually go up because those short positions must eventually be covered by actual purchases of the stock. As investors rush to cover short positions to stop losses, the price of the stock will rise sharply.
BREAKING DOWN 'Cushion Theory'
Technical analysts project price trends in the market based on trading volume and demand. Some consider it a bullish move if the short positions in a stock are twice as high as the number of shares traded daily. If you have a hunch that investors in short positions will soon need to cover those positions to minimize losses, then you should buy the stock to make a profit during the run up.