What is a Short Interest Ratio
A short interest ratio is the ratio between the numbers of shares of a stock being
at a given time to the total number of shares available for trade on a given day. Also known as the days to cover ratio, it is used by investors to measure market sentiment toward a specific
BREAKING DOWN Short Interest Ratio
Short selling is a trading strategy used by traders who want to bet that a stock price will fall. To short sell a stock, an investor borrows shares of that stock, promising to repay the stockbroker at a later date, and immediately sells those shares on the open market. When the shares do fall in price, the investor buys them on the open market, and repays the stockbroker with the now cheaper shares, profiting by the amount the stock fell in price.
Short selling can be risky however, because the potential losses are limitless. If you buy a stock, the most money you can lose is the amount you bought the stock for. If you short sell a stock, your potential losses are infinite, as there is no technical upper bound to how much a stock can grow in value. That’s why short sellers must pay very close attention to the short interest ratio, because it tells them how many days of trading would be required for them to cover their shorts, or repay the borrowed stock to their brokers.
The short interest ratio is also a useful measure for other investors to measure the overall market sentiment toward a specific stock. If the short interest ratio is very high, that means investors are shorting a large share of a company’s outstanding stock, suggesting that many investors expect the stock to fall in price.
Example of Short Interest Ratio
Let’s say you are an investor who wants to sell short stock in the New York Tire Company, because you believe that the CEO is too aggressively cutting prices in an ill-conceived plan to gain market share. The average volume of stock sold each day is 1,000 shares, while the number of shares being sold short is 200. That means the short interest ratio is 0.2. After one week, many other investors begin to agree with you, and now the number of shares being shorted is 800, meaning the short interest ratio has now risen to 0.8. This rising short interest ratio indicates a growing bearish sentiment for the stock of the New York Tire Company.