What Is Short Interest? Meaning and Definition

The term refers to shares that have been sold short but not yet covered or closed out. Short interest is reflected as the percentage of the outstanding shares, or the float. Investors can also assess the short interest based on how many shares are short alone, although this does not provide an accurate view. Without considering all the shares that are traded. 

It gives investors a clearer picture of the overall market outlook on a particular stock. Therefore the short interest is a proxy for market sentiment. When investors have a negative view over a specific company, they might short the stock. Therefore,it is usually a good way what the market view is on a particular stock.

If short interest is extremely high, it indicates that investors are extremely pessimistic (potentially overly pessimistic). However, significant changes in short interest also serve as warning flags since they indicate that investors are becoming more bearish or optimistic about a company’s future outlook

  • It measures the number of shares of a company that are currently being sold short and have not been covered.
  • While it is frequently expressed as a number, it is more informative when expressed as a percentage, either of the float or the shares outstanding.
  • It is a sentiment indicator: a rise in short interest frequently indicates that investors have grown more bearish. In contrast, a reduction in short interest indicates that investors have become more bullish.
  • Stocks with a high level of short interest, may be considered a bullish indicator by contrarians expecting a short squeeze

What does short interest tell investors?

It can shed light on the probable direction of a particular stock, as well as how bullish or bearish investors are about the market as a whole. In essence it is often used by investors to assess market sentiment towards a particular stock.

Short interest is quantified and reported by stock exchanges. Typically, they publish reports at the end of each month, providing investors with a benchmark for short selling.

A significant increase or reduction in short interest in a company over the previous month may be particularly suggestive of sentiment. For instance, when short interest in stock increases, it indicates that Mr. Market’s opinion toward the company is deteriorating. Such a significant movement may prompt investors to conduct more research on the stock, to find out exactly what is driving the bearish sentiment.

How to calculate short interest?

There are a few ways that investors can calculate short interest. They vary depending on the number of shares you want to divide by. 

Based on float 

Short interest based on float, gives investors an accurate picture of the impact on the shares available to be traded. 

Short Interest as a % of Float = Number of Shares Short / Number of Shares in the Float

Based on shares outstanding

It can also be assessed based on all of the shares that the company has. Although it gives investors a broader picture, the importance of this formula depends on how large the float of the stock is, relative to its outstanding shares.

Short Interest as a % of Shares Outstanding = Number of Shares Short / Number of Shares Outstanding

Short interest ratio

A useful measure in this case is short interest ratio. The short interest ratio allows investors to understand how many days it will take for short sellers to cover their positions. The short interest ratio divides the total number of shares that are short, by the average daily volume of that particular stock. This way investors are able to calculate approximately, how many days it will take for all the short sellers to cover their shorts.

Short Interest Ratio = Number of Shares Short / Average Daily Trading Volume

How does short interest relate to short squeezes?

Stocks with high levels of short interest are more prone to short squeezes. Stocks with lower floats and a high level of short interest are also more likely to experience short squeeze. As the number of shortable shares is lower. A short squeeze is an upward price movement induced by investor buying, combined with short sellers being forced to buy to avoid significant losses.

When analyzing a potential short squeeze it is extremely useful to use the short interest ratio. This is because it tells investors how many days on average it will take for short sellers to cover. The more days, the more impactful the covering volume will be on the stock price, if there is a sudden movement upwards. The longer the days to cover, the more negative investors are.

Limitations 

It is an informative and beneficial metric, but it is not the primary determinant of investment decisions. Although it is a useful to evaluate the market sentiment towards a stock’s future outlook, it should not be a decisive criteria when making investment decisions. 

It should be a piece of information to include in an investor’s overall analysis. Adjustments in short interest, even extremes, may not immediately result in major price changes. This is because short sellers may not cover their position right away.

As a rule of thumb investors should view the short interest as an assessment of the sentiment towards the company’s stock, and adjust that information into their analysis. It is also important to note that a high short interest does not directly mean that the stock will have abrupt movements.

Short interest based on float

There is no doubt that it is an extremely useful metric for investors. It is however important to be able to use it properly, so that you do not jump into conclusions. For example, short interest as a percentage of the float, should be carefully analyzed based on the float of that stock. If the float is a fairly low percentage of the shares outstanding, the short interest of the float will be more impactful. The opposite happens when the float is a large percentage of the shares outstanding. 

What is considered a high or low short interest?

Investors should not use this metric as a sole feature to determine a worthwhile investment. The question is what is a high or low short interest? and how can investors use this information to their benefit?

Low 

Well obviously a low short interest is when there are no shares short. This is highly uncommon, across most markets. However, a short interest on the float of under 10% is often considered low. It is usually a sign that the overall market sentiment in regards to that stock is highly positive. The lower the short interest, the more positive the overall market outlook towards that stock. 

High 

Although there is some debate as to what level of short interest could be considered high, there are a few levels that may be considered high. It is really dependent not only on the stock itself, but also on the market, and its participants. Nevertheless, when 10% or more of the shares are short relative to the float, it is a sign that there is a high short interest.

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