One issue with data on short selling is that it is not real-time in nature, unlike most other market data. Most major exchanges such as the New York Stock Exchange, Nasdaq, and the Toronto Stock Exchange, report consolidated short positions twice a month – at mid-month and month-end – as well as the net change from the previous report. The list of the most heavily shorted stocks on these exchanges often makes for illuminating reading.
While there are numerous indicators that can be used to evaluate a stock on the long side, there are comparatively fewer analysis tools on the short side. Two of the most useful indicators for analyzing potential short sales are short interest and the short interest ratio.
Short interest refers to the total number of shares sold short for a specific security, expressed as a percentage of the company’s total shares outstanding or its share float.
For example, consider a company with 100 million shares outstanding, of which 20 million are closely held and the balance 80 million are free floating. If the total number of shares sold short at month-end equals 20 million, short interest amounts to 20% of total shares outstanding, and 25% of share float.
This level of short interest would be considered high by any measure. As with any indicator, it is not just the absolute level of short interest, but also its trend over time that needs to be analyzed. An increasing level of short interest over the months may indicate growing bearishness towards the stock.
But at some point, very high short interest in a stock is viewed as a contrarian indicator, based on the notion that all those short positions will eventually have to be covered, which would presumably drive up the stock price.
Short Interest Ratio (SIR)
The short interest ratio (SIR) is calculated as the total number of shares sold short divided by the average daily trading volume in the stock. Thus, if a company had 20 million shares sold short, and average daily volume for the past 20 days is 2 million, the SIR is 10.
The short interest ratio can be interpreted as the number of days required to cover the full short position. In the above instance, it would be 10 days.
The higher the SIR, the greater the risk of a potential short squeeze. Given two stocks, one with a SIR of 0.5 and the other with a SIR of 10, the former would be viewed as being at significantly lower risk of a short squeeze. In particular, an inordinately high SIR caused by a combination of abnormally high short interest and relatively low trading volume would be considered as a risky short candidate.