To bet that the price of an asset will decrease, one takes a short position. Instead of making a purchase in the beginning, the trader borrows the asset, disposes it at the prevailing market price and intends to buy it back at a cheaper rate in future. This will only be possible if he buys low enough to cover the cost of repurchase and also makes some extra money from the deal.
Short
selling is common in both crypto derivatives markets and traditional stock
markets, especially among hedge funds, day traders, and market makers. Due to
the fact that losses on short positions can be unlimited, these trades often
require margin as well as strict risk controls.
What is
Meant by “Short Positions Liquidated”
Liquidation
of short positions occurs when traders who speculated on falling prices are
compelled by unfavorable market movement to offset their trades. It occurs most
times when there is a sudden rise in prices such that it goes beyond what the
trader can afford with his available margin.
In
leveraged markets, exchanges or brokers automatically close short positions
once losses reach a predefined threshold. To avoid any more losses, the system
buys back the asset at market price thus fixing the trader’s loss.
In simple
terms: prices go up, those who sold high are unable to buy back cheaply, so
their trade is closed down.
Why
Liquidations Can Drive Prices Higher
Short
liquidations are not just signals of market movements but they could also
exacerbate them. A forced buy order is initiated when a short position is
liquidated leading to increased buying pressure. If many short positions are
unwound simultaneously, it may result in a quick upward movement called a short
squeeze.
Short
squeezes are common in crypto markets due to high leverage and 24/7 trading.
They also occur in stocks, particularly when heavily shorted shares rise on
unexpected news or strong buying interest.
Where This
Happens Most Often
In crypto,
short liquidations are frequent during sudden rallies in Bitcoin, Ethereum, and
major altcoins. These markets experience sharp price changes because of their
high levels of leverage.
On the
other hand, short liquidations in stock markets usually take longer to unfold
but they can still be very dramatic. Meme stocks and small-cap names have seen
repeated short squeezes when buying momentum catches traders off guard.
Matters to
Traders and Investors
The reason
why prices move quicker than expected fundamentals lies behind short
liquidations. These events follow from market mechanics rather than fundamental
changes over time.
To
traders, short liquidations point out the dangers of using leverage. On the
other hand, for investors they help understand abrupt spikes which may
disappear after artificial demand ends.