Short Interest

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Short Interest Meaning

Short interest (SI) refers to the number of shares sold short but not yet purchased back by the short-sellers. In other words, it is the total number of outstanding shorted shares or open short positions resulting from the short-selling phenomenon.

FINRA encourages member firms to disclose SI positions in all "customer and proprietary accounts" in all equity securities twice per month. All SI positions must be reported by 6 p.m. Eastern Time on the second business day after the reporting settlement date. FINRA accumulates SI figures and initiates publishing on the 8th business day following the reporting settlement date.

Table of contents
  • Short interest (SI) refers to the number of shares sold short but not yet purchased back by the short-sellers, the total number of outstanding shorted shares.
  • SI ratio is obtained by dividing “short interest” (the current value of total open short positions) by “average daily trading volume.” It is also known as the “days-to-cover ratio.”
  • Generally, an increase in the SI is associated with the bearish sentiment, and a decrease in the SI is connected with a bullish sentiment.

Short Interest Explained

The short interest concept is inherent to the short-selling phenomenon. It happens when a company's share price shows a primary downtrend and investors read an opportunity to profit from that falling price. So short sellers borrow such shares, sell them, repurchase them at a price lower than the selling price, return to the owner and gain from the price differences. The short-sellers decide the gap between sale and repurchase based on factors like falling trend intensity.

The SI value helps investors ascertain the current market sentiments towards the stock. It is a common belief that an increase in SI value is a sign of investors' perception of the downward stock price movement. In contrast, a decreasing SI value points to investors' anticipation of the upward trend of stock price. In essence, high SI value happens when investors are bearish, and low SI value attributes to bullish investors. Furthermore, an increase in short selling can hint about future stock price crash risk. Short selling is also an indicator of weak governance mechanisms, excessive risk-taking behavior, and high information asymmetry between managers and shareholders.

An increase in SI value is not always an indicator of a downtrend, and it can also imply an upcoming uptrend. Proponents of this anticipate that the downtrend will be followed by upward movement. Furthermore, if a price rise happens instead of the anticipated price drop, short squeezers buy stocks, and panic-stricken short sellers start repurchasing stocks to avoid severe losses. All these create high demand, escalating the prices and forming an uptrend.

Short Interest Ratio Formula

The short-interest ratio is obtained by dividing "short interest," that is, the current value of total open short positions by "average daily trading volume." It is also known as the "days-to-cover ratio."

Short Interest Ratio Formula

As the name implies, the "days-to-cover ratio" indicates the average period required for short sellers to repurchase the shares. Generally, a higher SIR shows that the number of outstanding short positions increases or the average daily trading volume decreases. Hence increasing the SIR value indicates a bearish sentiment.

Calculation of Short Interest Ratio

Let's consider an entity with a short shares value of 11.94 million and an average trading volume of 3.5 million. Then the SIR value is calculated as follows.

SIR = SI/Average daily trading volume

       = 11.94/3.5

       = 3.41

Hence, it will take an average of 3 days for short sellers to buy back the short shares.

Limitation of Short Interest

The SI value does not assure any significant change in trend or continuation of falling prices. Another concern is the limited availability of reliable SI data. Hence, it is not a prime factor in investment decisions. Furthermore, SI value data drive short squeezers to jump into stocks with high short interest to drive the price high and make a profit.

For example, the excessive short interest of GME (Gamestop) in the initial times led to a price surge. Short-sellers are forced to purchase back shares at higher prices to close open positions when a heavily shorted stock price rises, propelling the stock price more. Based on analytics data from Ortex, shorting shares in GameStop cost hedge funds a total of $12.5 billion in January 2021. At the start of February again, the GME stock value declined and increased by the last week of February. The rise and drop sequence continued, and the SI value also fluctuated proportional to this.

Frequently Asked Questions (FAQs)

What is short interest in stocks?

It refers to the number of open short positions of an entity's stock. Investors engage in short selling by selling borrowed shares and later repurchasing them at low cost to benefit from the falling prices. Furthermore, there is no predefined time for deciding the repurchase of short shares.

What is a good short interest ratio?

A high SI ratio indicates bearish sentiment, and a low ratio suggests bullish sentiment in the market. A higher ratio reveals that it will take a lengthy period to close the short positions; for instance, the short-covering difficulty increases if the value is around ten or more.

Is high short interest bullish or bearish?

Generally, A high SI is considered bearish. Investors short sell the stock, which exhibits a primary downward price movement. However, traders initiating the short squeeze utilize this opportunity by buying the shorted shares and making short-sellers panic to cover their open short positions before price surge, temporarily creating a bullish trend. Furthermore, proponents of bullish trends advocate that a bullish movement will follow a bearish sentiment in the market.