What is short interest in stocks?
Short interest can serve as a useful indicator of how the market is moving, presenting traders and investors with an opportunity to get exposure. Learn more about what short interest in stocks is and how you can trade with us.
What is short interest?
Short interest represents the percentage of company shares that are sold short and haven’t been closed out. Traders will short-sell stocks if they believe that the share price will fall.
When there’s short interest in stocks, there tends to be a prevailing sentiment that the price will fall. That means that traders are sceptical about a particular stock. These traders are known as bears.
Inversely, a rise in long interest for a particular company will indicate a low short interest ratio. That’s when there’s a strong indication that the stock price will rise.
You can track short interest reports from stock exchanges where the company is listed to discover if it’s prone to short squeezes. This rate is presented as a percentage to indicate the number of shorted shares divided by the quantity of shares outstanding.
It’s important to note that short interest in a stock doesn't imply an impending price drop. Even though it's not always the case, it’s generally viewed as a negative indicator. However, you’d still find some bullish traders that might see this as an opportunity.
The rate only serves as an indicator of the prevailing sentiment about a particular security, seen through an overwhelming number of traders selling their position or shorting the market.
Therefore, short interest reading must be supported by extensive technical and fundamental analysis of a market. This is important because short interest analysis can be conducted on individual stocks or on an entire industry.
Examples of how to use short interest
There are two ways to use short interest. Your trading strategy will dictate the best course of action when there’s a noticeable short interest in a market.
Firstly, you can track days to cover, which is a calculation based on the number of short positions in a stock divided by the trading volume. A high day to cover measurement could signal a short squeeze, which is where there’s a sudden spike in price caused by a large number of short sellers holding their position.
For example, let’s say company XYZ has an average daily volume of 1 million shares. If traders short 2 million shares that haven’t been closed out, then the days to cover would be two days.
Another way of using short interest is to take a long position on a company that’s being short squeezed, in hopes that the price level will bounce back over time. Generally, when you opt for a long squeeze, you’re pressured to sell your position based on the falling market in order to limit your losses.
By not selling, you anticipate that the stock price will rise again. They may be required to buy more shares to cover or simply hold their position. There’s always risk that the market may continue to fall for a longer period than you have anticipated. That’s why it’s important to take steps to manage your risk.
How to perform a short trade
You can perform a short trade on stocks that have short interest by using our CFD trading account. This derivative product enables you to speculate on the direction of the price of the underlying asset, without taking outright ownership.
To get started, we’ve listed a few steps that will help you get ready to trade with us:
Search for your opportunity
Select ‘buy’ to go long, or ‘sell’ to go short
Set your position size and take steps to manage your risk
Open and monitor your position
CFD trading
CFDs can also be used to hedge against an existing position to offset any potential losses. You can get exposure via leverage trading, whereby you’d get full exposure, with just a small initial deposit – known as the margin.
It’s important to remember that, with leverage, both your profit and loss are magnified. This means that you stand to lose more than your initial deposit because your position is calculated using the full size of your position, not just the deposit. That’s why you need to take steps to manage your risk effectively.
Short interest pros and cons
Pros of short interest
- You can use short interest as an indicator of market sentiment before you get exposure
- It can also offer you an opportunity to hedge your position against potential downside risk
Cons of short interest
- Relying solely on stock exchange reports on short interest may result in loss as the indicators aren’t available in real time, potentially misrepresenting the market
- Short interest may reflect uncertainty in the stock market at a certain point, possibly providing a sentiment about a particular stock that could change rapidly, leading to a short squeeze even though the short interest ratio is low
Short interest in stocks summed up
Short interest is the number of company shares that are sold short and haven’t been closed out
It’s represented as a percentage that can be used as an indicator of investor sentiment in the market
You can use short interest to short-sell stocks with the aim to profit if the market price falls
The advantage of using short interest is that it can serve as an indicator of investor sentiments in the market. The disadvantage of using short interest is that it can be misrepresent the market as conditions may move rapidly than the report on shorted stocks
You can short stocks with us using our CFD trading platform
This information has been prepared by IG, a trading name of IG Markets Ltd and IG Markets South Africa Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
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