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Article rating : 0.00, 0 votes. Author : Larry Potter
Here’s a good barometer for the strength of a market rally or sell-off. It’s also worth considering when you are evaluating the purchase of an individual stock.
Simply put, “short interest” is the total number of shares of a stock currently sold short. Each index combines the total number of shares held short for its member firms and produces a report for “NASDAQ short interest” or “NYSE short interest.” Also of interest is the “short interest ratio” which is the number of trading days at average daily volume required to cover total short interest positions.
When the market or a particular stock is under pressure, short sellers suddenly appear to take advantage of the weakness and force prices down. They make money as the stock or index falls.
If the market or stock turns around, many short sellers will immediately buy shares to “cover” their short position. Others will hold on to their position hoping that weakness will return and they’ll make more money. If the rally continues, more and more short sellers will cover their positions as the pain of a losing play hits home. The covering adds more buying to the rally. If the shorts run to cover at the same time, the surge in buying can produce a “short squeeze” with terrific results for folks on the long side of the action.
These days it is important to watch overall short interest to get a feel for the strength of the postwar rally in stocks. For example, NASDAQ short interest was 4.15 billion shares in October versus 4.06 billion shares in September. When the upswing was gathering momentum in June, short interest was 4.6 billion shares. That means that approximately 350 million shares went from the short column to the long column when positions were covered. It was a factor in the positive move. Meanwhile, short interest at the NYSE was 7.43 billion in October, 7.34 billion in September and way up at 8.03 billion in June.
You should check short interest in an individual stock, too. The number of shares held short is important; more important, in our view, is the “short percentage of float.” That’s the number of shares held short versus the total number of shares available for trading. If the percentage for your stock is, say, 5%, short interest probably won’t have a big impact on your trade. However, if it’s 15% or higher, the odds increase that a rally will cause many shorts to cover and perhaps ignite a squeeze.
We noted a high short interest of 26% for homebuilder Toll Brothers (TOL) when we featured that companyback around March 9, 2002. The firm had just announced a 2-for-1 stock split, and we wanted to take advantage of the excitement over the split to grab some short-term profits. We figured that short covering would help us.
Sure enough, TOL split from around 52 to 26 and then raced to 32 for a 23% gain in a poor market environment.
Even though the DOW and NASDAQ and most stocks are in rally mode today, you should nevertheless take a periodic peak at short interest for a glimpse of the future.
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