What Is Short Interest in a Stock?
The short interest in a stock is a rough gauge of market sentiment toward that stock. Specifically, it tells you how much investors are betting that the price of the stock will go down in the near future. People making such a bet are referred to as taking a short position on the stock.
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Shorting a Stock
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When you expect the price of a stock to rise, all you have to do to make a profit is buy some shares, wait for the price to go up, and then sell them. But when you expect the share price to fall, it's not so easy, because you have to figure out a way to sell shares before you buy them. That's where shorting comes in. To short a stock, you borrow shares from a dealer or some other third party and sell them at the current market price. Once the stock's price goes down, you buy shares at the new price to give them back to the dealer. The difference between the selling price and the buying price -- minus any commissions and interest you pay to the dealer -- is your profit.
Short Interest
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When you buy shares at the new price to return them to the dealer, it's called covering your short position. Short interest tells you how many shares of a company's stock have been sold short, but have not yet been covered. Short interest is a raw number, one that you have to view in the context of how many shares of the stock are being bought and sold, also known as the volume of the stock.
Ratio
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Short interest ratio, commonly called just short ratio, looks at short interest in relation to trading volume. To get the ratio, divide the short interest by the average daily trading volume. For example, say the short interest on a stock is 18 million shares -- that is, investors at some point will need to buy 18 million shares to cover their short positions -- and on an average day, 8 million shares change hands. Divide 18 million by 8 million, and you get a short interest ratio of 2.25. The short interest ratio is also called days to cover, because it tells you how many days, under current conditions, it would take for all investors to cover their short positions.
Uses
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Short interest can give you a sense of what the market thinks about a stock, particularly when you compare it to the float, or the number of shares that are available for trading (rather than owned by the company itself or held by mutual funds). If a stock has short interest of 8 million shares but the float is 300 million shares, fewer than 3 percent of shares are being shorted. That's a lot different from a float of only 50 million, in which case 16 percent of shares are short. The short ratio, meanwhile, indicates the risk of not being able to cover a short position. The higher the ratio, the greater the chances of a short squeeze. A squeeze occurs when there isn't enough volume on a stock to allow investors to cover their positions. Since demand exceeds supply, the share price rises -- and suddenly, the investors are at risk of losing money on their short positions.
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