What Is Short Interest and What It Calculates

May 3, 2023
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By reflecting the number of shares sold short that remain outstanding, short interest might represent a general market attitude toward a firm. When measured, it can be a useful but imprecise indication of whether a stock is bullish or bearish.

To fully comprehend short interest, first understand how short selling happens. An investor who shorts a stock borrows shares and then sells them to buyers ready to pay the market price. To return the shares to the lender, the investor must eventually buy them back. If the price falls, the desired outcome, the investor will win since they purchased the shares for less than the purchasers did.

The investor, on the other hand, will lose money if the price rises. As a result, short selling is regarded as speculative. Short selling carries high risk since the investor may spend more to repurchase the shares than they got from the first sale. This is what might occur if there is a "short squeeze."

What is short interest?

The number of shares sold short and still outstanding is referred to as short interest. Traders often sell a security short if they believe the price will fall and borrow shares of stock to do it. After that, the investor sells the borrowed shares to purchasers ready to pay the market price.

Short interest is frequently used to gauge the current market atmosphere. Short interest increases frequently indicate that investors have gotten more negative, while short interest decreases indicate that traders have grown more optimistic. Short interest is frequently stated numerically or as a percentage. The Financial Industry Regulatory Authority (FINRA) mandates businesses to report short interest holdings in all equities securities in all client and proprietary accounts twice a month.

What does short interest indicate?

Short interest may reveal information about a stock's probable trend and how optimistic or bearish traders regard the economy as a whole. Each month, stock exchanges assess and report on short interest, giving investors a tool to employ as a short-selling reference.

A significant rise or reduction in short interest in stock from the month preceding might reflect investor mood. If short interest in stock increases from 10% to 20%, it could indicate that negative sentiment against the firm is rising, as the number of investors expecting the stock price to fall has doubled.

The number of short shares may also be changed into a ratio, commonly known as days to cover, by dividing it by the average daily trade volume. The short interest ratio calculates how long a stock's shorted shares would take to be covered or bought in the market.

Shorting a stock to increase short interest

Short interest rises when more traders short an asset. The following indicates the steps for shorting an asset:

  1. Borrowing the stock. Usually, the investor will reach out to their broker, who will identify another shareholder with the stock and borrow it from them with an agreement to return it later. The stock may also be loaned to the trader by the brokerage from their capital investments. The investor pays the broker fees and interest for renting the shares.
  2. Selling the stock. The investor will then sell the shares on the open market right away.
  3. Repurchasing the stock. As the stock's value falls, the investor will buy it back at a reduced price. Short covering is the act of repurchasing a shorted stock.
  4. Returning the stock. The investor will then benefit by returning the borrowed assets to the broker. The gain is the difference between the price at which the trader sold the stock and its repurchased price. If the asset price increases after the investor sells short, they will lose money since they will have to offer a higher price to buy the shares.

Short interest formula

Short interest can be exhibited as a percentage of float or as an absolute numerical value. The following formula is used to represent interest as a percentage:

Short interest = (Number of shares short and not covered / Share float) * 100%

Application of short interest

An increasing amount of short interest in a company does not imply that the assets will decrease in price; rather, it indicates that many investors believe the stock will decline in price. A stock's short interest or short float may be calculated by dividing the number of shares sold short by the float by the total number of shares available for purchase by the public.

Short float percentage = number of shares sold short / number of shares in a float

This proportion is the percentage of publicly accessible shares that are borrowed.

Short interest may be used to gauge market sentiment for an organization's shares or the stock market, and some optimistic traders see it as an opportunity. The use of short interest as an indicator has significant drawbacks. Short interest statistics, such as those given by the New York Stock Exchange (NYSE) monthly, are not timely and may not accurately represent market circumstances. Furthermore, a company might be significantly shorted for an extended time without experiencing a short squeeze or a price fall.

The relevance of short interest

Short interest in a firm is used to gauge investor sentiment toward the shares. Therefore, it reveals how investors perceive the company's shares. Investors maintain an average level of short interest in most equities.

When a company's short interest rises, it is frequently an indication that stock sentiment is bearish (negative) and that traders expect the stock price to fall. When it falls, on the other hand, it indicates to investors that stock sentiment is bullish (positive).

While short interest is essential for shareholders, it ought not to be the only factor considered when making investing decisions.

Limitations of using short interest

Even though short interest is a beneficial tool, it should not be used solely as the determinant of an enterprise's decision. Below are a couple of limitations of short interest:

  • Unreliable signals. Developments in short interest do not predict many market developments. Similarly, a company might be significantly shorted for an extended time without experiencing a short squeeze or a price fall.
  • Report updates are infrequent. The data is published only monthly if an investor monitors Short Interest reports, such as the NYSE Short Interest Report. Short interest is updated twice a month by the Nasdaq. Market circumstances can vary considerably more quickly, making occasional report updates less important given evolving trends and a constantly changing news cycle.

Short squeeze

A short squeeze occurs when the price of an asset abruptly rises, gaining momentum, and many short sellers quit their holdings in an attempt to cut losses. This can result in additional shorts being forced to cover, propelling the stock further into a vicious cycle. Short squeezes can occur without warning at times. Unexpected positive news might spark an equity price surge, resulting in a short squeeze in a highly shorted company. If this occurs, short sellers must be ready to make swift judgments to exit. As you may expect, this is a risky position for short sellers. Furthermore, some contrarian traders may purchase equities with high short interest to profit from a short squeeze.

Misconceptions about short interest

FINRA releases Short Sale Volume Data alongside Short Interest Data. The Daily Short Sale Volume data offers aggregated volume for all off-exchange short sale trades per securities. This data does not include any trade activity not made available to the public and is not combined with exchange data.

Some investors incorrectly infer that the bimonthly short interest data is underestimated because the Short Sale Volume Daily File depicts significantly more turnover than what is reported as short interest. However, short interest position data does not correspond to FINRA's daily short sale volume statistics and is not designed to do so.

The short interest data is only an illustration depicting brokerage companies' short holdings at a certain time on two distinct days each month. The Short Sale Volume Daily File indicates the aggregate volume of trades conducted as short sells under particular constraints on individual trading dates. As a result, while the two data sets are connected in the sense that short sale volume activity might lead to a reportable short interest position, they do not constitute the same details.

Short positions in securities may be established by investors and continue to exist for variable amounts of time, resulting in a short position being recorded in one of the data sets but not the other. An investor, for instance, may sell an asset short and then buy shares to settle the position on the same transaction day. The position would not be included in the short interest statistics, but the short sale transaction would be included in the Short Sale Volume Daily File.

A trader, on the contrary, may maintain a short position open for days or weeks, sometimes as insurance against another investment. While the short sale trade that produced that short position would display only on the day the short sale transaction happened, the short position would be recorded in the short interest statistics for as long as the position stayed open. 

What you need to know about short interest information

Some online sources may republish the Short Sale Volume Daily File and refer to it as "short interest," however, this is erroneous since, as previously stated, short sale volume data is not the same as short interest position data. Furthermore, the source determines the precise information an investor sees. Frequently, the data displayed on free investor websites is the product of a proprietary algorithm rather than the short interest data disseminated by FINRA and the exchanges. FINRA has no control over the methodology of different data sources to calculate and publish short sale information. Investors are recommended to obtain information from the data supplier to understand better how the data shown was generated.

Short interest ratio

The short interest ratio analyzes the number of shares shorted to the average trading volume of an asset. This ratio determines how long it would take for all of an asset's shorted shares to be covered or repurchased in the market. The greater the ratio, the greater the trading volume necessary to cover the stake. Investors frequently employ the ratio to estimate if shorted shares in an asset will take a long time to be covered. The trader may be cautious about selling a stock short in this case.

Below is the formula used to calculate the short interest ratio:

Short interest ratio = Short interest / Average daily trading volume

Short interest vs. short interest ratio

Short Interest and Short Interest Ratio do not refer to the same thing. Short interest is a quantity or proportion of shares sold short, while the Short Interest ratio is used to predict how many typical trading volume days would be necessary for the entire quantity of shares sold short to be covered or redeemed.

Comparison of short interest to a put/call ratio

The put/call ratio and short interest are both measures of the market atmosphere. The quantity of outstanding short shares is the subject of short interest. The put/call ratio gets its information from the options market. Put options are considered bearish bets, whilst calls are considered bullish stakes. Variations in the put/call ratio are a further indicator that may be used to predict whether prices will grow or decline.

What is a beneficial short interest?

Short interest, as a float proportion less than 10%, depicts a very optimistic sentiment. Short interest as a proportion of float over 10% is relatively high, suggesting strong pessimism. Short interest as a float proportion is exceptionally high, over 20%.

Can 20% be considered as a high short interest?

Yes, it is considered as high short interest. Short interest as a percentage of float greater than 20% is considered overbearing and reflects an extremely negative outlook.

How can you know when a stock is being shorted?

If you are interested in figuring out if a stock is being shorted, you may look at the business's financial statements. The organization's short interest will be recorded on the balance sheet as "short-term investments." You may also look at the stock exchanges where the shares get traded to find out if any regulatory filings about short-selling activities have been filed.

Conclusion

Short interest measures how many shares of a firm are sold short and have not yet been covered. Short interest is frequently stated numerically, although it is more instructive as a percentage. A short-interest hike usually indicates that traders are becoming more pessimistic, while a short-interest fall indicates that traders have become more optimistic. Short interest may be utilized for evaluating market sentiment for a company's stock or the financial sector as a whole, and some traders use it to determine if it is beneficial to short that company's shares.