|Page: Short Stock Positions - How to Short a Stock and Where To Find Short Interest Data|
Short stock positions arise when the short seller borrows shares from his broker and immediately sells them on the open market. He then waits, hoping for the stock price to decrease, when the short seller can profit by purchasing the shares back on the open market. Of course, in order to profit from this trade, the short seller buys these shares back at a lower price than initially paid for borrowing and returns them to his broker to reverse his short stock position.
Thus, the profit of the short seller is the difference between the price received after selling the borrowed shares on the open market and the price paid when he buys the shares back in order to return them to his broker.
Schematic representation1 of how to short stocks:
There is an interesting article written on Investopedia about When to Short a Stock which you can read by clicking on this link.
There are three key indicators that are commonly used to measure the level of short interest in a stock: the short interest (as a percentage of a stock’s total amount of shares outstanding), the short interest as a percentage of a stock’s total float and the short interest ratio. You will find a more detailed explanation below.
To find out how I use these indicators in my own stock investment analysis, I refer you to the article: Shorting a Stock - How I Determine if a Short Squeeze is Likely.
The short interest is calculated by dividing the total amount of shares short by the total amount of shares outstanding and is often expressed as a percentage. By also calculating the change in short interest you can even gain more insights into Mr. Market's2 thoughts about the expected direction of the stock's share price, as an increase in short interest means Mr. Market is more certain that the stock price will decline, and vice versa.
According to the report of Asher Curtis and Neil Farger, titled: "Does Short Selling Amplify Price Declines or Align Stocks with their Fundamental Values?", the average short interest is 2.4%. By applying the 80/20 rule to this percentage, I have determined the average short interest range at 1.9% to 2.9% (rounded 2% to 3%).
The float refers to the total number of shares available for trading. Thus, the float is calculated by subtracting the restricted shares, the insider ownership and the shares owned by shareholders who own at least 5% of the company's total shares outstanding. The difference between this ratio and the 'standard' short interest is that the long-term shareholders are now excluded, as Mr. Market expects that these ownership groups will not sell their shares in the near future.
The outcome of this ratio will be higher than the outcome of the 'standard' short interest calculated above, as the same amount of shares short are now divided by a smaller amount of shares, i.e. only those shares which are available for trading.
The short interest ratio is derived by dividing the total short position by the average daily trading volume, generally calculated over the last 30 trading days. The short interest ratio is also referred to as days to cover, as it is a rough estimate of how many days it would take the shorters to buy back all of their shorted shares at the stock’s average daily trading volume. Thus, the higher the short interest ratio is, the more vulnerable the stock is to a short squeeze (as it will take longer to buy back the shares necessary to close the short stock position).
After interpreting a great deal of data found on the internet, I concluded that the average short interest ratio range is 4 to 6. As an example, I found this graph3 of the NYSE short interest for the period 1996 to 2001, as shown below.
Twice a month, brokerage firms are required to report the number of shares that have been shorted in their client accounts to the appropriate regulators. This information is totalized for each stock and then released to the public.
Short interest is the total number of shares of a stock that have been sold short by investors but have not yet been covered or closed out. Stocks with a high short interest can be quite risky as an investment for two reasons:
Short squeeze: when the price of a stock with a high short interest begins to rise, short sellers will often reverse their positions and therefore add to the demand by buying shares to cover their short positions, causing the share price to increase even further.
You might be asking yourself where to find the online data regarding short stock positions, short interest and days to cover. Fortunately, there are some great free resources for this information. As my stock portfolio is mainly concentrated in Canadian and American stocks, I will describe these resources below.
To analyse the short stock positions in a specific Canadian stock, you can best use the Short Position Tool from Stockwatch.com. The short positions for the TSX and TSX-Venture are reported twice per month (on the 15th and on the last day of every month). Stockwatch.com receives the actual reports three days later and then updates this data on their website. You can find this data by visiting: http://www.stockwatch.com/Analytics/Shorts.aspx?action=go&symbol=TCM®ion=C. By replacing 'TCM' at the end of the url by the ticker symbol of the company you would like to know the short stock positions of, you will be redirected to this company's short position report. In this case TCM redirects to the short position report of Thompson Creek Metals.
In order to view the short positions in all American listed companies you can go to www.shortsqueeze.com.
In addition you can visit HighShortInterest.com who provides a convenient sorted database of stocks which have a high short interest of over 20 percent.
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Cautious Note: Never buy or sell a stock because the short interest suggest you should. Always complete your due diligence as a whole before you decide what to do with the specific stock on your radar.
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1 Image Source: http://en.wikipedia.org/wiki/Short_(finance)
2 Mr. Market is a concept from Mr. Benjamin Graham bestselling book: The Intelligent Investor
3 Source: http://www.technicalanalysissite.com/indicators/the_nyse_short_interest_ratio.htm