DEFINITION of Long-Short Ratio
A long-short ratio represents the amount of a security available for short sale compared to the amount that is actually short-sold. The long-short ratio can be used as an indicator for a specific security, but can also be used to show the value of short sales taking place for a basket of securities or for the market as a whole. The ratio is impacted by the demand for securities borrowing for short sale, and by the supply of securities available for short sale. It can be used as a market sentiment indicator. A large percentage of participants shorting the market indicates bearish sentiment.
BREAKING DOWN Long-Short Ratio
The long-short ratio represents the amount of a security available for short selling versus the amount actually borrowed and sold. The long-short ratio is considered a barometer of investor expectations, with a high long-short ratio indicating positive investor expectations. For example, a long-short ratio that has increased in recent months indicates that more long positions are being held relative to short positions. This could be because investors are uncertain how new short sale regulations will affect the market, or that volatility is making short sales more risky investments.
Hedge funds typically make up a large portion of the short sale market. This is related to their long/short strategies. If hedge funds reduce their short sale positions, as happened during the 2007-2008 financial crisis, the long-short ratio will increase. Regulators consider short selling a factor that led to the financial crisis, and have increased scrutiny on the industry.
The ratio can be affected not only by the demand of investors interested in borrowing securities for short sale, but also by the supply of securities available for short sale. Pension funds, for example, typically hold securities long-term. If they are unwilling to lend, then high demand from hedge funds will not matter.