Interpreting Short Interest

Short interest is a measure of how many shares of any given security have been sold short in a period of time. Typically, a stock exchange produces a monthly report on the total amount of short interest in any given stock. This number is expressed as a percentage of stocks sold short which have not yet been covered compared to the total outstanding shares of the stock. The higher the short interest, the more investors are betting the stock will fall in price. However, a very high short interest can be the predecessor to a rise in stock price.

Calculating short interest

When an investor sells a stock short, they are betting the price will fall. They will borrow the shares from a trader, sell them at the current price, then repurchases them in the future to hand back to the trader. When the shares have been returned, the contract is covered and closed out. The difference in the sale price and repurchase price goes into the investor's pocket as profit. With any stock, an analyst can know how many shares have been sold on margin, and this indicates how many investors must repurchase the stock in the future to settle the short sale transaction. This percentage of shares outstanding that has not been repurchased is the short interest of the stock. For example, if 500,000 shares of Security C are held in short positioned that must be covered, and C has 5 million shares, then 10 percent of C is held in short interest. 

High short interest indication

Depending on C's trading history, 10 percent may be a high amount of short interest. In this case, an investor will know there is a relatively large amount of shares that must be repurchased in the near future in order to cover short sale contracts. As a result, C's price may be temporarily inflated when these investors repurchase shares to cover. It would be a bad time for an individual to start a new short sale contract on C. However, it may be an excellent time for an investor to purchase shares of the stock outright or to purchase a contract for difference on the stock with a short maturation. Both of these could turn out to be highly profitable in the short term, given the stock's current high short interest.

Low short interest indication

When a security is experiencing a period of low short interest, it can indicate investor sentiment about the security is actually quite high. Very few investors believe the security's price will fall. For example, if Security C has only 2 percent short interest when compared to the earlier 10 percent, an investor knows short sale tactics have dropped substantially. Most people holding shares in the security are doing so in order to profit off the company's growth. If an investor believes the security will take a turn for the worst, this would be a good opportunity to sell short. 

blog comments powered by Disqus