What Is Short Interest?
Short interest is the number of shares that have been sold short but have not yet been covered or closed out. Short interest, which can be expressed as a number or percentage, is an indicator of market sentiment. Extremely high short interest shows investors are very pessimistic (potentially overly-pessimistic). When investors are overly-pessimistic it can lead to very sharp price rises at times. Large changes in the short interest also flash warning signs, as it shows investors may be turning more bearish or bullish on a stock.
What Does Short Interest Tell You
Short interest can provide insight into the potential direction of an individual stock, as well as how bullish or bearish investors are about the market overall. Stock exchanges measure and report on short interest. Typically, they issue reports at the end of each month, giving investors a tool to use as a short-selling benchmark. The Nasdaq exchange publishes a short interest report at the middle and end of each month.
The Difference Between Short Interest and the Put/Call Ratio
Short interest and the put/call ratio are both indicators of market sentiment. Short interest focuses on the number of short shares outstanding. The put/call ratio uses the options market for its data. Put options are bearish bets, while calls are bullish bets. Changes in the put/call ratio are therefore another gauge that can be used to determine whether investors are expecting prices to rise or fall in the future.
Limitations of Using Short Interest
Short interest can be telling and a useful tool, but it is not meant to be the sole determinant of an investment decision. It is a data point to add as part of an investor’s overall analysis. Changes in short interest, and even extremes, may not lead to significant price changes in a timely fashion. A stock can stay at an extreme reading for long periods of time without a short squeeze or more major price decline. Also, many major price declines are not forecast in advance by rising short interest.
Short interest is published once a month by most exchanges, and twice per month by the Nasdaq. The information traders are using is thus always slightly outdated and the actual short interest may already be significantly different than what the report says.