What Is Short Interest?
Short interest is the number of shares that have been sold short and remain outstanding. Traders typically sell a security short if they anticipate that price will decline by borrowing shares of stock. The investor then sells these borrowed shares to buyers willing to pay the market price.
Short interest is often an indicator of current market sentiment. An increase in short interest often signals that investors have become more bearish, while a decrease in short interest signals they have become more bullish.
Short interest is often expressed as a number or percentage. FINRA requires firms to report short interest positions in all customer and proprietary accounts in all equity securities twice a month.
- Short interest indicates how many shares of a company are currently sold short and not yet covered.
- Short interest is often expressed as a number yet is more telling as a percentage.
- An increase in short interest often signals that investors have become more bearish, while a decrease in short interest shows they have become more bullish.
What Does Short Interest Signal?
Short interest can provide insight into the potential direction of an individual stock, as well as how bullish or bearish investors are about the market overall. Stock exchanges measure and report on short interest and issue reports each month, providing investors a tool to use as a short-selling benchmark.
A large increase or decrease in a stock's short interest from the previous month can indicate investor sentiment. If the short interest for a stock rises from 10% to 20%, it may be a warning sign that negative sentiment is growing toward the company as the number of investors who expect the stock price to decrease has doubled.
Short interest can also be converted into a ratio, also known as days to cover, by taking the number of short shares and dividing it by the average daily trading volume. The short Interest ratio indicates how many days it would take for all of a stock's shares that are sold short to be covered or repurchased in the market.
If short interest is one million shares, and its average daily trading volume is 100,000 shares, it will take at least 10 days on average for the shorts to be able to cover their positions.
Short Interest Ratio = Short Interest/Average Daily Trading Volume
This ratio indicates how many days it would take for all of a stock's shares that are sold short to be covered or repurchased in the market.
How to Use Short Interest
If a stock has a rising level of short interest, it doesn't mean that the stock will fall in price, but only that a high number of investors are betting that the stock will fall in price. An investor can calculate short interest or short float for a stock by dividing the number of shares sold short by the float, the total number of shares available for the public to buy.
Short Float Percentage = Number of Shares Sold Short/Number of Shares in Float
This percentage indicates the percentage of shares available to the public that is borrowed.
If a company has 10 million shares of stock outstanding and 1 million shares are sold short, the total short interest is 10%.
Short Interest can be used as an indicator of market sentiment for a company's stock or the market as a whole and some bullish investors see high short interest as an opportunity. There are some limitations to using short interest as a marker. Short interest reports, such as those provided monthly by the NYSE, are not timely and may not reflect market conditions. Also, stock can be heavily shorted for a long period without seeing a short squeeze or a price decline.
What Are the Limitations of Using Short Interest?
Short interest is a useful tool but should not be the sole determinant of an investment decision. Changes in short interest, and even extremes, may not lead to significant price changes in a timely fashion. A stock can stay at an extreme reading for long periods or a major price decline. Short interest is published only monthly by most exchanges so traders are using slightly outdated information and the actual short interest may already be significantly different than what the report indicates.
What Is a Short Squeeze?
A short squeeze occurs when a high number of short sellers attempt to cut their losses and exit their short positions by purchasing their borrowed shares due to panic about potential losses and often occurs if a stock price rises.
How Does Short Interest Compare to a Put/Call Ratio?
Short interest and the put/call ratio are both indicators of market sentiment. Short interest focuses on the number of short shares outstanding. The put/call ratio uses the options market for its data. Put options are bearish bets, while calls are bullish bets. Changes in the put/call ratio are another gauge that can be used to determine whether investors are expecting prices to rise or fall in the future.