Using Short Interest to Identify Trading Opportunities
Short interest is a key metric used to identify bullish or bearish sentiment in a stock and potential trading opportunities, especially in volatile or contrarian situations. High short interest typically indicates bearish sentiment in a stock while low short interest can confirm bullish sentiment.
A short sell is when shares are sold short by an investor and have not yet been closed out. There are a number of financial websites that publish short interest including MarketWatch and Yahoo Finance.
Calculating the short interest in a stock involves dividing the number of shares sold short by the total numbers of shares outstanding, or the float. For example, if a company has 100 million shares of stock outstanding and five million shares that are sold short, the short interest would be 5%.
- Stock Float = 100 million
- Shares Sold Short = 5 million
- Short Interest (%) = 5 million ÷ 100 million = 5%
Since the short interest is expressed as a percentage, the 5% short interest can then be compared to industry peers to evaluate how that company is performing against its competitors.
Traders also like to confirm or calculate how many days it would take short sellers to cover, or buy back, the position. This can be calculated by taking the total short interest and dividing it by the average daily volume.
Fundamental and technical analysts often watch the short interest in a stock to gauge the level of pessimism surrounding the underlying company. Generally, if short interest exceeds 10% of a company’s float, it can be a warning signal that the financials, or the business itself, needs some work. If these situations worsen, short interest can climb up into the 30%-40% range.
It is important to note that short interest can also create fuel for explosive short squeezes. If a heavily-shorted company were to perform better-than-expected, a minor share price rise could soon turn into a sharp upward spike which is a phenomenon known as a short squeeze.
Better-than-expected earnings, contracts awards, a new product, or an analyst upgrade can spark short squeezes. As short-sellers look to close out their short positions, the crowded number of buyers attempting to exit by repurchasing shares at once can cause a squeeze, and share price to increase.
The potential downside for short positions is unlimited, so losses are not capped at 100%. This is one of the biggest risks in selling a stock short.
At the time of this article, the stocks with the highest short interest include:
Innovative Eyewear (LUCY) 70% short interest; Kohl’s (KSS) 54% short interest; Rocket Companies (RKT) 45% short interest; and Beyond Meat (BYND) 41% short interest.
Short squeezes are unpredictable and often news-driven. When trading stocks with high short interest, remember crowded trades can reverse violently and high short interest does not always mean a stock will squeeze, as short interest could be justified.