E While Congress Is Meeting To Discuss High Short Interest, The Real Problem May Be Incredibly Low Short Interest

Over the last few months, I have mentioned that short interest seemed to be lower than usual. I have mentioned it in articles and in commentaries to members of my newsletter, The Hedged Alpha Strategy. I didn’t have verifiable proof, but it was just an observation based on looking at short interest as an indicator for many years and from looking at different stocks each week.

Short interest by itself doesn’t provide much insight unless you put it in to some sort of context. The two most common ways of measuring short interest are as a percentage of the float and the short-interest ratio. Short interest as a percentage of the float simply takes the number of shares sold short and divides it by the total number of shares outstanding.

If there are five million shares sold short and 50 million shares outstanding, that 10% of the float sold short. That would be a pretty high percentage and it could serve as a bullish signal in a contrarian manner. If there are 500 million shares in the float, it means only 1% of the float is sold short. That’s a pretty low percentage and wouldn’t garner much attention.

The short interest ratio simply takes the number of shares sold short and divides that number by the average daily trading volume. This tells investors how many days of average trading volume it will take for the short sellers to cover their position should they need to.

Using the example from above, if the stock that has five million shares sold short sees 2.5 million shares change hands each day, the short-interest ratio is 2.0. If the stock only sees an average volume of 500 thousand, that’s a ratio of 10.0. The first ratio is a little low and the second ratio is pretty high. If I was considering a bullish trade on the stock in question, I would be encouraged by a short interest ratio of 10.0. Once again, if the stock rallies like I think it will, short-sellers trying to cover their positions can add buying pressure to a stock that is already rallying.

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