What is short interest in stocks?

What is short interest?

Short interest represents the percentage of company shares that are sold short and haven’t been closed out. Traders will short-sell stocks if they believe that the share price will fall.

When there’s short interest in stocks, there tends to be a prevailing sentiment that the price will fall. That means that traders and investors are sceptical about a particular stock. Inversely, a rise in the interest for a particular company will indicate a low short interest ratio.

You can track short interest reports from stock exchanges where the company is listed to discover if it’s prone to short squeezes. This rate is presented as a percentage to indicate the number of shorted shares divided by the quantity of shares outstanding.

It’s important to note that short interest in a stock doesn't imply an impending price drop. Even though it's not always the case, it’s generally viewed as a negative indicator. However, you’d still find some bullish traders that might see this as an opportunity.

The rate only serves as an indicator of the prevailing sentiment about a particular security, seen through an overwhelming number of investors selling their position or shorting the market.

Therefore, short interest reading must be supported by extensive technical analysis and fundamental analysis of a market. This is important because short interest analysis can be conducted on individual stocks or on an entire industry.

Examples of how to use short interest

There are two ways to use short interest. Your trading strategy will dictate the best course of action when there’s a noticeable short interest in a market.

Firstly, you can track days to cover, which is a calculation based on the number of short positions in a stock divided by the trading volume. A high day to cover measurement could signal a short squeeze, which is where there’s a sudden spike in price caused by a large number of short sellers holding their position.

For example, let’s say company XYZ has an average daily volume of 1 million shares. If investors short 2 million shares that haven’t been closed out, then the days to cover would be two days.

Another way of using short interest is to take a long position on a company that’s being short squeezed, in hopes that the price level will bounce back over time. Generally, when you opt for a long squeeze, you’re pressured to sell your position based on the falling market in order to limit their losses.

By not selling, traders anticipate that the stock price will rise again. They may be required to buy more shares to cover or simply hold their position. There’s always risk that the market may continue to fall for a longer period than you have anticipated. That’s why it’s important to take steps to manage your risk.

How to perform a short trade

To get started, we’ve listed a few steps that will help you get ready to trade with us:

1. Create an account or log in
2. Search for your opportunity
3. Select ‘buy’ to go long, or ‘sell’ to go short
4. Set your position size and take steps to manage your risk
5. Open and monitor your position

You can perform a short trade on stocks that have short interest by using our CFD trading account. This derivative product enables you to speculate on the direction of the price of the underlying asset, without taking outright ownership.

Alternatively, you can buy into shorted stocks with hopes of benefiting in the long run using our stock trading platform. When you become a shareholder, you’ll have voting rights and receive dividend payments if the company grants them.

Short interest pros and cons

Pros of short interest

• You can use short interest as an indicator of market sentiment before you get exposure
• It can also offer you an opportunity to hedge your position against potential downside risk

Cons of short interest

• Relying solely on stock exchange reports on short interest may result in loss as the indicators aren’t available in real time, potentially misrepresenting the market
• Short interest may reflect uncertainty in the stock market at a certain point, possibly providing a sentiment about a particular stock that could change rapidly, leading to a short squeeze even though the short interest ratio is low

Short interest in stocks summed up

• Short interest is the number of company shares that are sold short and haven’t been closed out
• It’s represented as a percentage that can be used as an indicator of investor sentiment in the market
• You can use short interest to short-sell stocks with the aim to profit if the market price falls
• The advantage of using short interest is that it can serve as an indicator of investor sentiments in the market. The disadvantage of using short interest is that it can be misrepresent the market as conditions may move rapidly than the report on shorted stocks
• You can short stocks with us using CFDs or invest in shares outright using our stock trading platform