What is the 'Short Interest Ratio'
The short interest ratio is a sentiment indicator that is derived by dividing the short interest by the average daily volume for a stock. Also known as the days to cover ratio, it is used by both fundamental and technical traders to identify the prevailing sentiment the market has for a specific stock.
BREAKING DOWN 'Short Interest Ratio'Shorting a stock is the opposite of buying a stock. Specifically, it is the selling of a stock that is not owned by the investor. The goal of selling a stock short is to make money when it falls to a lower price. The investor is betting that the price of the stock will go down. Once the price goes down, the investor can buy the stock at the lower price without having to own the stock. The expectation is for the price of the stock to go down. Looked at in aggregate, short interest and the short interest ratio can provide clues about the level of bearish sentiment in the market.
Short Interest Percentage vs. Short Interest Ratio Calculation
Short interest is the number of shares shorted in the market. The level of short interest is calculated by dividing the number of shorted shares by the number of shares outstanding. For example, a stock that has 1 million outstanding shares sold short, and 5 million shares outstanding in total, has a level of short interest that can be described as 20%, or 1 million divided by 5 million. The more people that short the stock, the higher the level of short interest.
The short interest ratio is the ratio of the number of shares shorted to average daily volume. If a company has 1 million shares shorted and an average daily volume of 200,000, it will take five days to cover all shares sold short in the market, calculated as 1 million divided by 200,000.
Short Interest and Short Interest Ratio Interpretation
When short interest grows, it means more investors are covering their positions because they are worried about and/or expect the price of company stock to go down. If a company's short interest increases by 20% in one month, it means there was a 20% increase in the number of investors that are betting on the stock price going down.
The short interest ratio provides a number that is used by investors to determine how long it will take short sellers, as a number of days, to cover their entire position if the price of a stock begins to rise. The short interest ratio can also be applied to exchanges to determine the sentiment of the market as a whole. If an exchange has a high short interest ratio of around five or greater, this can be taken as a bearish signal, and vice versa.