A number of new trading platforms have emerged in an effort to engage new retail investors. The resulting push toward individual wealth management birthed a generation of active day traders. What this group lacks in value they more than make up for in volume.

Financial analysts and economists could not have predicted that this community would engage in battle with hedge funds in a volatile market.

Short Squeeze Recovery

Headlines exacerbate the volatility of high trading days. This generally serves to create more of the same behaviors that sparked the originating activity. The sharp rise in stock prices due to excessive short sells steeply inflate both market activity and demand for a particular stock.

Recent events related to top retail outlets bring light to a new trend of short squeeze activity. Pooled hedge fund investments depend on high trading volumes and turnover to increase returns. Risk management within this investment vehicle requires leverage and impeccable timing.

Worth the Risk?

Short selling is a major strategy for hedge funds. Experienced fund managers are quite familiar with short squeeze tactics and factor in the additional risk when contemplating investment options. The most recent scenarios have some hedge fund risk analysts skittish. 

The unprecedented growth of new investors driven by the global pandemic has created a new risk factor that fund managers must now consider. The lure of the return is now balanced with the uncertainty of the outcome. Hedge funds face investment challenges today that simply could not have existed even a decade ago.

Bubbles, bankruptcies, and bailouts are part of the natural investment cycle in a free market economy. Navigating through those circumstances requires a solid understanding of the impact and a plan to circumvent potential disasters. Unfortunately, inexperienced investors make it more difficult for other investors to accurately gauge their own best moves. What retail traders lack in monetary value, they make up for in group numbers and trading volume.

There is no easy answer to the short squeeze dilemma. The potential for fast and steep gains is simply too hard to resist for some investors. Hedge fund managers must be able to effectively delineate between the wants and needs of their investor base.

Appraisal Economics provides exceptional valuation services for hedge funds and private equity firms. Our expert services range from valuations of portfolio companies to complex securities. For over 30 years, we have helped fund managers navigate the challenges surrounding complex valuations.