What is Short Interest?
Short interest refers to the number of shares sold but not yet repurchased or covered. The short interest of a company can be indicated as a number or percentage of shares outstanding and is looked at by investors to determine the prevailing sentiment over a stock.
Short Interest: Shorting a Stock
Recall that short interest is the “number of shares sold but not yet repurchased or covered.” Therefore, it increases when more investors short a stock. Below indicates the process of shorting a stock:
1. Borrow the stock
The trader will typically contact its broker, who will locate another investor who owns the stock to borrow the stock from them with the promise to return the stock at a predetermined later date. The trader pays fees and/or interest to the broker for borrowing the stock.
2. Sell the stock
The trader will then immediately sell the stock on the open market.
3. Repurchase of stock
As the stock declines in value, the trader will then repurchase the stock at the lower price. The repurchase of a shorted stock is referred to as short covering.
4. Return the stock
The trader will then return the borrowed stock to the broker and earn a profit.
In the steps outlined above, short interest is created when the trader sells the stock but have not repurchased the stock (steps 2-3).
Importance of Short Interest
The short interest in a company is used to assess sentiment around its stock. In other words, it provides insight into how investors feel about the company’s stock.
When the short interest of a company increases, it is often a warning sign that the stock sentiment is bearish (negative) and that investors expect the stock price to decline. On the other hand, when it decreases, it provides an indication to investors that the stock sentiment is bullish (positive).
Although short interest is important to investors, it should not be the sole determinant when making investment decisions.
Formula for Short Interest
The short interest can either be expressed as a number or as a percentage of float. In expressing the concept as a percentage, the following formula is used:
Example of Short Interest
ShortSqueeze.com provides information regarding the short interest volumes of public companies. Facebook (Ticker: FB) shows a short interest of 34,462,100 with 2,380,703,100 shares in float. Determine the short interest for Facebook as a percentage.
Understanding Short Squeeze
When talking about short interest, the topic of short squeeze often comes up. Short squeeze is used to describe a situation where a stock with a significant amount of short interest increases dramatically in price, forcing short sellers to cover their short positions.
A short squeeze is caused by a sudden positive development in a stock, resulting in a strong bullish sentiment and a sharply rising share price. In a short squeeze, traders who do not cover their short positions run the risk of enduring substantial losses. Stocks with high short interest are more susceptible to a short squeeze.
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