What Is a Squeeze?
The term squeeze is used to describe many financial and business situations, typically involving some sort of market pressure. In business, it is a period when borrowing is difficult or a time when profits decline due to increasing costs or decreasing revenues.
In the financial world, the term squeeze is used to describe situations wherein short sellers purchase stock to cover losses or when investors sell long positions to take capital gains off the table.
How Squeezes Work
The term is used liberally in finance and business and describes any situation wherein people are realizing losses, taking gains, or finding credit financing difficult. Several types of squeezes—including profit squeeze, credit squeeze, short squeeze, and long squeeze—are explained below.
[Important: Squeeze situations are often accompanied by feedback loops that can make a bad situation worse.]
Types of Squeezes
A profit squeeze is realized by a business when its profit margins have decreased or are decreasing. This type of squeeze happens when a company's revenue declines or its costs rise. The underlying causes of a profit squeeze are numerous but commonly consist of increased competition, changing governmental regulations and expanding producer and supplier power.
A credit squeeze describes any situation where it becomes difficult to borrow money from banking institutions. This type of squeeze normally happens when an economy is in a recession or when interest rates are rising. The issuance of bad debt, such as in the case of the 2008 financial crisis, often causes a recession and a credit squeeze. Rising interest rates occur because the Federal Reserve deems the economy is healthy enough, and consumer confidence is high enough, to assume a higher rate of interest. A credit squeeze can thus occur in a down market and an up market.
A short squeeze is a common scenario in the equities market where a stock's price increases and its purchase volume spikes because short sellers are exiting their positions and cutting their losses. When an investor decides to short a stock, he is betting the price declines in the short term.
If the opposite occurs, the only way to close the position is to go long by purchasing shares of the stock. This causes the stock's price to further increase, resulting in further action by short sellers.
A long squeeze occurs in a strong financial market when there are sharp price decrease and investors who are long a stock sell a portion of their position, pressuring more long holders of the stock into selling their shares to protect against a dramatic loss. This normally happens because investors place a stop-loss order to mitigate risk and ensure they are protected against any price declines.
Even when prices are increasing, they often do so with volatility, and short downward swings can trigger the sell order.
- The term squeeze can be used to describe several situations that involve some sort of market pressure.
- Profit squeezes, credit squeezes, and short squeezes are all examples of when a market pressure accelerates or intensifies a financial situation.
- Squeeze situations are often accompanied by feedback loops that can make a bad situation worse.
Other Types of Squeezes
A liquidity squeeze occurs when a financial event sparks concerns among financial institutions (such as banks) regarding the short-term availability of money. These concerns may cause banks to be more reluctant to lend out money within the interbank market. As a result, banks will often impose higher lending requirements in an effort to hold onto their cash reserves. This cash hoarding will cause the overnight borrowing rate to spike significantly above its benchmark rate, and as a result, the cost of borrowing will increase.
A financing squeeze is when would-be borrowers find it difficult to obtain capital because lenders fear making loans. This often leads to a liquidity crisis if there is little cash on hand and not enough operating cash flow.