What Is Short Interest, and Why Does It Matter to Traders?

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 that they have become more bullish.

Short interest is often expressed as a number or percentage. The Financial Industry Regulatory Authority (FINRA) requires firms to report short interest positions in all customer and proprietary accounts in all equity securities twice a month.

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.

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 by the total number of shares available for the public to buy.

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 New York Stock Exchange (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.

The Bottom Line

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 it 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. Short interest can be used as an indicator of market sentiment for a company’s stock or the market as a whole, and some investors use this as an indication that it might be profitable to short that company’s stock.