Risk Ratios: An Early Indication Of A Short Squeeze

Risk Ratios Intro

Many years ago, I was working on ways to identify market trends using what I called “Risk Ratios.” The idea was to use ratio analysis of major market indices or index ETF products to gauge things like inflation expectations, market valuation, cyclical trends and large-scale short covering. Every Friday, I take time to review these indicators in during my daily session on TheoTrade. One of these indicators I’ve been following closely is on potential short covering that began in early November and has exploded this week.

There are official stats on short interest but it’s hard to get a close look at this on a real-time basis. For the most part, it’s not about the absolute number, but rather the trend. A short squeeze is when those traders who have already sold the stock short, rush to cover their shares by buying the stock. This rush to buy the stock can create large moves in the price.

Risk Ratios Inputs

Relative strength analysis doesn’t give you any indication of whether the price of each component is rising or falling, and Risk Ratios won’t as well. The most important considerations are the inputs and trend of the ratio. Using this concept, the idea is to take two products that are positioned opposite each other. They won’t be negatively correlated because they’re stocks. However, one will typically outperform another in certain circumstances. My short squeeze risk ratio uses the following products:

  • Invesco S&P 500 High Beta ETF (NYSEARCA: SPHB)
  • Invesco S&P 500 Low Volatility ETF (NYSEARCA: SPLV)

Risk Ratios: SPHB

This high beta product is a natural when discussing the “risk” part of Risk Ratios. What’s more associated with risk than high beta stocks. Here’s a description from the Invesco website:

“The Invesco S&P 500® High Beta ETF (Fund) is based on the S&P 500® High Beta Index (Index). The Fund will invest at least 90% of its total assets in the securities that comprise the Index. The Index is compiled, maintained and calculated by Standard & Poor's and consists of the 100 stocks from the S&P 500® Index with the highest sensitivity to market movements, or beta, over the past 12 months. Beta is a measure of relative risk and is the rate of change of a security's price. The Fund and the Index are rebalanced and reconstituted quarterly in February, May, August and November.”

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William K. 1 month ago Member's comment

It appears that a fair amount of insight and experience is required to see these clues as to what comes next. Much more insight than math.