Short Interest represents the number of shares sold short that have not been closed out. Investors may interpret it as a measure of how pessimistic investors are towards a certain stock.
What Is Short Interest?
Short Interest is a measure of the total number of shares/units of an investment security that have been sold short and remain outstanding (meaning they have not yet been repurchased or covered to close out the short position). Traders typically sell an investment security short if they anticipate that price will decline in the near future.
What Is Short Selling?
Short selling, or to "sell short," means that an investor, or short seller, borrows and sells shares of an investment security, expecting to buy the borrowed security back at a lower price on a later date. The short seller then returns the borrowed security to the lender and hopefully makes a profit.
Warning: Shorting is not for the faint of heart, and can expose investors to unlimited losses. Markets are unpredictable and short sellers can end up losing money if the security price goes up instead of down as they expected.
How Short Interest Works
Short Interest, which can be expressed as a number or as a percentage, measures how many shares of an investment security investors have sold short and remain outstanding. A common use of Short Interest is to gauge investors' collective attitude or sentiment about a particular investment security or about the market more generally.
Short Interest can be analyzed for an individual stock, a sector, a broad market index, or the market as a whole. Market exchanges, such as the NYSE, report on the Short Interest of stocks at the end of each month.
What Short Interest Means For Investors
If an investment security has a rising level of Short Interest, it doesn't necessarily mean that the investment security will soon fall in price. It just means that a higher number of investors are betting that that the investment security will fall in price.
Furthermore, some investors short an investment as a hedging strategy to protect another long position. Long investors might in fact assess higher levels of Short Interest as a reason to do more diligent research for themselves to ensure they understand what is causing others to bet against the stock.
Short Interest as an Indicator of Market Sentiment
Many investors sell short because they expect prices for a particular investment security to fall. For this reason, an high amount of Short Interest can mean that investor sentiment is pessimistic.
Some contrarian investors may interpret high Short Interest as an indication that market sentiment is too pessimistic, which can be interpreted as a bullish signal. Another reason some investors bet on stocks with heavy Short Interest is due to the knowledge that eventually those short sellers will have to repurchase the stock, meaning there's guaranteed buying interest in the future.
Short Interest Formula & Example
To calculate Short Interest for a stock, divide the number of shares sold short by the float, which is the total number of shares available for the public to buy. Another term for Short Interest is short float percentage, which is the percentage of the float that is borrowed.
Short Interest = Number of Shares Sold Short / Number of Shares in Float
For example, let's say a company has 100 million shares of stock outstanding and 2 million shares sold short. Here's the Short Interest calculation:
2 million / 100 million = 2% Short Interest
Short Interest Ratio Definition & Formula
The Short Interest ratio is a ratio that compares the number of shares of a stock versus the stock's average trading volume. Used interchangeably with a related term, "days to cover," 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.
Here's the formula for Short Interest ratio:
Short Interest Ratio = Short Interest / Average Daily Trading Volume
Short Interest Ratio vs. Short Interest
Short Interest and Short Interest ratio are not the same thing. Short Interest measures a number or percentage of shares sold short, whereas the Short Interest ratio is used to estimate how many normal trading volume days would be required for the total number of shares sold short to be covered or repurchased.
What Is a Short Squeeze?
A short squeeze occurs when a high number of short sellers attempt to quickly cut their losses and exit their short positions by purchasing their borrowed shares. A short squeeze often happens because short sellers panic about potential losses if the stock price rises.
The more a stock price rises, the more losses a short seller takes on. Short sellers who want to put an end to their losses get "squeezed" out of their short positions by purchasing shares, which then makes the stock price climb further. If a stock is heavily shorted, the squeeze becomes larger.
Limitations of Short Interest
Short Interest can be used as an indicator of market sentiment around a particular security or the market itself. However, there are some limitations of Short Interest, such as infrequent updates and inconsistent signals.
- Infrequent report updates: If an investor follows Short Interest reports, such as the NYSE Short Interest Report, this information is only updated on a monthly basis. The Nasdaq updates Short Interest twice-monthly. Market conditions can change at a much faster pace, making infrequent report updates less relevant to shifting trends and an ever-changing news cycle.
- Inconsistent signals: Many market changes are not signaled in advance by changes in Short Interest. Similarly, a stock can be heavily shorted for a long period of time without seeing a short squeeze or a decline in price.
A high level of Short Interest does not always mean that a stock price or a segment of the market is headed for a correction. Short Interest can be a useful tool for an investor or trader but it should never be used as a sole determining factor in making investment decisions.
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