White Top View series on Short Selling, Part 11
Both long and short investors can gain
insight by analysing short sale data
In fact short-selling analytics and money-making insights go together. All investors that pay attention to the short selling data can find valuable information. Often it directly applies to money-making opportunities. Extract the right insights from the data and increase your money-making potential.
Today we continue with Part 11 of the White Top View series Short Story on Short Selling. Click the links at the end of the post to read each earlier part of the series.
Analysis of short selling uncovers useful information
Experienced or novice, long or short, all investors can benefit from short selling analytics. Like all market activity, short selling leaves a trail of data. Analyzing that information can produce useful investing insights.
Stock exchanges make short selling statistics available to the public in regular reports. Typically, data gets posted as reports on stock exchange websites twice a month.
That information provides both positive and negative market signals. To some investors the data indicates opportunity while others see the same information warning of trouble to come.
One thing remains obvious to everyone. When looking at the list of companies with shares sold short, most companies are not on the list. Most companies have no shares sold short against them. Most companies listed on all stock exchanges are held by long only investors.
Of the relatively few companies that have shares held in short positions, very few have short positions held against them quarter after quarter. There are always exceptions, and some short battles can go on well beyond a year.
However, most short battles play out over a few weeks or months. And, in general, relatively few companies ever have shares held in short positions.
Short selling numbers you need to know
Total number of shares issued
Number of shares sold short
Number of shares traded each day
The total number of shares issued by a company can range from a very few to over a billion. The typical public company has multiple millions of shares issued. The key information is knowing the total number of shares outstanding for each company of interest.
By itself the total number of shares issued means little. We need it and two more numbers for comparables that we can judge.
The next number, the count or number of shares actually sold short, lets us calculate some key information. We can then relate the number of shares sold short to the total number issued.
The short interest
The comparison of shares sold short to the total number of shares issued reveals the short interest. Normally that calculation gets reported as the percentage of total shares that are held short.
Short interest indicates of the strength of the negative outlook on that stock. If say, selling 2% of the shares short, far more or 98% of the shares stay long! The short sellers will need a good story or negative news to get much downside action. By themselves they are not likely to cause much selling.
Still, when any level of short selling first gets reported, the least confident investors can spook and quickly sell. But unless the short interest grows, usually, little else happens.
However, when the short reports show 20% or more of the shares sold short, there certainly is much greater reason for concern. That 20% defines the lower end of larger short positions. Even if somewhat arbitrary, however, knowing of such short interests is certainly useful information. It gets wide attention for full-blown long-short battles.
Should the short interest get too high a short-term bullish situation could be developing. Remember, the shorts have to cover or buy back the shares.
When the short interest gets near or over 50%, the basic math begins to work against the shorts. Then, once buying back begins, a bear or short stampede can happen. The basic math goes against the shorts. There simply are not enough shares for all the shorts to profitably cover. Dramatic price spikes quickly happen.
Days to cover the short position or short interest ratio
One more number further informs us. We need to know the number of shares traded during a typical day. We divide the total number of shares short by the average number traded and learn the days to cover.
Short interest ratio or days to cover gives the days of total trading volume the shorts need to cover or buy back and close their short position. The 50 day average number of shares traded is typically used.
That average reports the volume or number of shares traded over the previous 50 trading days. That gives us the average of 10 weeks or about 2 ½ months of trading volume history.
Using the 50 day average smooths out spikes or dips from any change in short-term or recent activity. That makes sure any extra quiet or very active trading days do not skew the overall message or impression.
Compare only comparable numbers
Understand the numbers you use especially when comparing between different stocks listed on different markets. Some exchanges report the number of shares outstanding and others use the float.
The shares outstanding are the total number issued. The float usually means the number held by the public.
However, there are variations in obtaining and reporting the float number. That leaves room for some creative numbers which can mean possible manipulations or oversights.
Some exchanges also give historical information as a measure of short interest. In my view, total shares outstanding provides the most reliable and comparable number. It is the only consistent and reliable number to use.
Whatever number, make sure that comparisons get made using numbers obtained in the same way.
What we know
We know that short sellers must buy back the shares sold short. Right or wrong in their strategy, they must repay the borrowed shares.
That opens the door to being right about a short but still losing money. At times shorts get it right in their business analysis and short strategy, but still lose on the covering trade. They can get squeezed at the buy back and see their profits quickly evaporate.
Most often, that happens when there are too many shares sold short. Thus, there are simply not enough shares to buy back at prices that allow all shorts to profit. Once that squeeze starts, a stampede to cover can rapidly unfold. Prices get driven up as all shorts attempt to minimise their loss.
Observers of short battles look for such bullish opportunities. They watch the days to cover as a key indicator. It points to the pending buying pressure that must come.
The more days to cover the greater the coming upside pressure. Possibly a very bullish sign. It can predict a coming short squeeze. Quickly buying long to have shares for selling to covering shorts at higher prices can produce much excitement and very profit.
But that is a very risky way to make money. This is not for new investors or beginners just learning to trade, under any circumstances.
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These discussions and information intend to help you better understand markets and investing. I am not a financial or investment advisor; opinions are for informational and educational purposes only and are not intended as investment advice. For syndication of the site or blog, please contact info@WhiteTopInvestor.com.
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Links to all parts of the White Top View series, the Short Story on Short Selling, follow below:
Part 8, Short selling has rules
Part 10, Four more positives of short selling
Part 12, Shorting stocks is hard