The short interest ratio is a mathematical indicator showing the average number of days it will take for short sellers to buy to cover the borrowed shares of a stock in the open market.
The short interest ratio is calculated by dividing the total number of shares short of a stock by the average daily trading volume on the exchange. When the short interest ratio is high it means the amount of shares that will need to be bought back by short sellers is high. When the short interest ratio is low it means that the amount of shares that will need to be bought back by short sellers is low. This ratio represents pent up buying pressure for the short sellers at some future date. This ratio can become so high that it becomes bullish.
The short interest ratio is calculated by dividing the total number of shares short for a stock by the average daily trading volume.
The short interest ratio formula: Short interest ratio = Short interest/Average daily trading volume
The short interest for a stock shows the market sentiment on that stock. A high short interest shows there are a lot of bearish bets against the stock and a low short interest can show that sentiment is bullish. The most important thing to consider with short interest is when it reaches extremes in either direction.
Very high amounts of short interest can show extreme pessimism and that a stock may be oversold and due for a bounce due to eventual short covering. When traders are too bearish at lows in a stocks chart it can cause fast price reversals higher due to short covering rallies. Heavily shorted stocks tend to rally very fast as rallies feed on their self causing short sellers to panic and buy back the stock has it goes higher.
Heavy short interest is built in future buying pressure for a stock. Short positions are two-sided trades, they just reverse the order by selling first and buying second. Each short position in a stock is a future buyer that has to cover. The rate of change in short interest levels can signal changes in sentiment in either direction.
Stock exchanges quantify and report short interest usually once a month for the stocks they list. Most report the end of month short interest shares and percentage. The NASDAQ publishes short interest in a report in the middle and also at the end of every month.
A trader can watch a trend in short interest as it grows or is reduced. Short interest in a stock that goes from 5% to 10% has doubled and shows growing bearishness expressed as short positions. Short interest that grows over 40% can start to create bear traps and short squeezes as they could be selling short too late in a downtrend. A company stock will eventually find a bottom in price as all the negative fundamentals are priced in and reflected and then rally higher, or go to the pink sheets and eventually $0 in bankruptcy.
Days to cover short positions quantifies the number of trading days of buying it would take to buy to cover and close out the total quantity of outstanding shares short. The days to cover is calculated by with the number of current shares short divided by the amount of the average daily trading volume for the stock.
- Days to cover from one to four usually still reflects bullish sentiment.
- Days to cover from five to nine starts showing growing bearishness on a stock.
- Days to cover over ten can signal extreme bearishness.
What is a high short interest percentage?
- Short interest below 10% signals bullish sentiment.
- Short interest over 10% starts to signal bearish sentiment.
- Short interest over 20% starts to show extreme bearish sentiment.
- Short interest over 30% can start signaling it is late in the bearish price cycle.
- Short interest over 40% can start exposing short sellers to the dangers of a short squeeze or a temporary ‘dead cat bounce.’
The short interest ratio in a stock is a technical indicator that gauges a range of bearish to bullish sentiment and is used to identify extreme levels for potential reversals in price.
