SHORT INTEREST - NYSE

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APPLICABLE TIME FRAME(S):  

LONG

UPDATE SCHEDULE:

Data is released monthly, around the 20th of the month.  The data is updated here by 7:00 PM EST the evening the data is released.

REPORTING DELAYS:

Several days, covering the activity over the prior month.

EXPLANATION:

Short selling is one way to give a person the ability to profit from a falling stock. It is the selling of a security that the seller doesn't own. One borrows a stock (or futures contract or option), then sells it, hoping to replace those borrowed shares by buying them back at a lower price and thus earning a profit.

If the security goes up from the price at which you initially sold, your loss is the difference, and it can be unlimited.  That's the risky part of short-selling - your potential profit is limited while your risk is unlimited (if you are un-hedged). 

Short interest is the total number of shares of a stock that have been sold short but not yet covered. The NYSE reports the total short interest for each stock once per month, usually around the middle of the month.  These are only trades that are already settled, so there is some lag in the reporting. 

A large increase or decrease in short interest can be a good indicator of sentiment.  A high (or rising) short interest means that a large amount of people believe that a stock will go down, similar to the short futures contracts from the Commitments of Traders data and high put/call ratios. 

The short-interest ratio is the total number of shares sold short (short interest) divided by average daily volume. This is also called "days to cover" because it shows - given the security's average trading volume - how many days it will take to cover all of the short positions. The higher the ratio, the longer it would take to buy back the borrowed shares, and the potentially more bullish it is.  It is potentially bullish because if some positive catalyst occurs, then there may be heavy buying demand from those short looking to cover (buy back) their shares.

Just as individual stocks have short interest ratios, so do the exchanges as a whole, which are simply the addition of all the individual stocks.  The traditional way to calculate the short interest ratio on the NYSE is to take the short interest on all the individual stocks on the exchange and divide it by the average daily trading volume on the NYSE over the past month. 

So, for example, if there were two billion shares sold short at the end of the reporting period, we would divide that by the average daily volume on the NYSE for the same period, say, one billion shares per day. This would give us a NYSE short ratio of 2, which means that it would take two days to cover all of the short positions. A higher ratio means there is more bearish sentiment on the exchange. 

There are some challenges here, mainly the fact that short interest is very seasonal.  It is lower in the early months of the year and higher in the later months, probably because of tax implications.  We have analyzed each year from 1943-2002 and adjusted the short sales to normalize these effects. 

This gives us a better perspective of actual sentiment rather than seasonal influences.  Also, instead of using just one month's volume to calculate the ratio, we use the past 12 months, which helps to cancel out seasonal volume influences as well.

GUIDELINES:

When we see a buildup in short interest, that provides a base for those shorts to eventually cover, driving prices higher.  Therefore, high short interest ratios tend to be bullish.  Conversely, low short interest ratios mean that traders are optimistic about the long-term prospects of the market, and have decreased their short holdings.  This robs the market of a potential short-covering base, and tends to be bearish.

We can see from the chart below that the tremendous bull run in the late 1990's was preceded by a large buildup of short interest.  The covering of those shorts was in part responsible for the continual march higher in equities.  Once the buying reached a frenzy, however, and short interest dropped to very low levels (compared to recent history), the short-covering fuel became spent and the market could not sustain its upward momentum.

Although this is a real example and points out the value of following this information, we do not mean to intimate that the market ALWAYS peaks when short interest is low, or troughs immediately after the short interest ratio reaches 6.7 or above.  It is a guideline and not a trading system unto itself.

STATS:

*Standard Deviation.  See below...

68% of readings (1 standard deviation) should be between 4.7 and 6.7

95% of readings (2 standard deviations) should be between 3.7 and 7.7

99% of readings (3 standard deviations) should be between 2.7 and 8.7

In other words, we should expect a reading under 3.7 or over 7.7 approximately 13 times per year.  Since such a reading would be relatively unusual, it suggests that we may be seeing an unsustainable trend.  These figures assume a normal distribution curve.

ADDITIONAL RESOURCES:

New York Stock Exchange (www.nyse.com)

© 2005  Sundial Capital Research, Inc.  All Rights Reserved.