Short Interest Explained

Do other people’s opinions matter in the stock market?

Unfortunately, they do; but fortunately, understanding the public sentiment can help us predict what’s going to happen in the future. If we can simply see what the investing public is feeling, we can (at least in theory) predict how they will react to bullish and bearish news and prepare our portfolios accordingly.

One way of seeing how investors feel about particular stocks is through short interest. This metric is just a number that tells us how much of the total outstanding shares of a stock are being used in short positions, and therefore, what percentage of investors think that the stock is in for a rough near-term future. 📉

However, when markets are seemingly sliding into a recession and volatility is high, short trades are often easier to make than long-term bullish plays. And if a trader wants to use this opportunity while minimizing the risks associated with shorting, they must know how to do their research—and short interest is a key component in every short seller’s toolbox.

In this guide, we will discuss how short interest works, what information it can really tell us, and how it can be used in combination with other analysis tools to provide sensible market signals. Let’s get straight to it.

What you’ll learn

• The Definition of Short Interest
• Why is Short Interest Important?
• Examples of Using Short Interest
• How to Calculate Short Interest
• Short Interest vs. Call/Put Ratio
• Pros and Cons of Short Interest
• Conclusion
• Get Started with a Stock Broker

The Definition of Short Interest 📚

In stocks, short interest is the number of shares that have been sold but have not been covered yet. In other words, it is the percentage of existing shares of a company that was borrowed by short sellers but hasn’t been paid back to their owners.

Namely, shorting stocks consists of borrowing shares, selling them, and then buying them later (hopefully at a much lower price) to pay back the lender while making a profit. In this context, short interest is a metric that tells us how bearish the market’s sentiment toward a stock is.

Moreover, short interest is a key metric in fundamental analysis: Even if more short interest means more negative market sentiment, a very high short interest percentage makes a stock vulnerable to a short squeeze which can decimate short sellers’ positions. There is a bit more nuance to short interest, so let’s take it apart one piece at a time.

What Short Interest is Not 🧐

Short interest data is published by the Financial Industry Regulatory Authority. However, FINRA also publishes data on short sale volume—this shouldn’t be mistaken with short interest even though it looks and sounds similar.

In short (awful pun intended), short sale volume is the aggregated volume for a given security for all short sale trades made off-exchange. However, short sale volume doesn’t include any trades that haven’t been made publicly known for one reason or another.

Even though undisclosed short sales have been common on Wall Street for a long time, regulators have started making moves to curb undisclosed short selling after the scandal with Gamestop in 2021. Nonetheless, short sale volume might be inaccurate even though it comes from a good source because of this—one more reason why it shouldn’t be mistaken with short interest.

Why is Short Interest Important? 👨‍🏫

Looking at short interest is an easy way to check how many investors believe that a company will lose value in the future. Moreover, since short selling is very risky, short sellers—most of which are institutional investors like hedge funds—don’t enter short positions lightly.

Short interest is a measure of market sentiment, but only strong negative market sentiment. So, short sellers can lose a lot if the company they betted against gains value—like Melvin Capital did when it shorted Gamestop—and so, short sellers often attack companies they are certain will win against.

It is also not uncommon for hedge funds to gang up on a stock, raise its short interest through the roof, and reap the rewards when the markets react to the increased short interest by selling. This can be considered a form of market manipulation, but institutional investors usually don’t get harassed for that sort of thing, so for us regular investors, it is just one more market circumstance to watch out for.

All in all, the short interest of a stock sends a signal to the markets: Maybe the stock deserves to be shorted to oblivion, maybe it is under attack by those with the ability to tweak the markets in their favor, and maybe the short sellers went too far and a short squeeze is imminent. 

It is also possible to look for a trading opportunity after the short interest dissipates. For example, GME’s quick jump invited many more short sellers and created an opportunity for another short squeeze in 2022.

What Investors Can Learn from Short Interest  📖

Before cracking a joke in front of everyone, you should definitely adjust your tone to their mood, otherwise, the joke might turn out distasteful or unfunny. And before going short on long on a stock, it pays to see what the markets think about it before putting any money on the table. 

For investors, short interest can be insightful as it raises a red flag—a stock with a significant short interest is at risk of losing value, but if it recovers, it will recover harder. Namely, short sellers borrow shares and have a legal obligation to buy them back and return them to the lender later on.

Regardless of how much a stock costs, short sellers on the wrong side of destiny are obliged to buy them, raising the price even further. As investors, we have no reliable way of knowing which scenario will manifest—this often makes securities with a high short interest unpredictable.

Even though short sellers often claim that shorting exposes bad companies, punishes them, and makes the markets more efficient as a result, we have also seen that in some cases, shorting is a greedy practice or a power struggle as can be seen by the conflict between Bill Gates and Elon Musk over Tesla and climate change. All in all, short interest is an important fact that doesn’t point toward a clear outcome, but ignoring it when researching stocks is to ignore a crucial risk factor.

What Short Interest Doesn’t Tell Us 🤔

Most of the business conducted in the stock markets is public, but some is done using incognito methods. Because of this, not all relevant data ends up included in a stock’s short interest level.

Unlike regular shorting, naked shorting is a practice of selling a stock without even borrowing it. Essentially, you sell something you don’t have using a special contract, and as long as the price of the shorted stock drops, you can buy the shares you owe at a lower price than what you ‘sold’ them for. Essentially, naked shorting means shorting a stock without buying or borrowing it beforehand.

Because of this, naked short positions aren’t included in a stock’s short interest—and even though there are laws in place to limit this practice, it has been going on for a while and doesn’t seem to be going anywhere. Needless to say, a stock’s short interest can be much greater than what public data seems to indicate, which can amplify the effect that a stock’s short interest will have on its future price.

Examples of Using Short Interest 📝

As we’ve discussed, high short interest can mean that a stock is facing massive negative sentiment and will drop in the future, but it can also present an opportunity for a short squeeze. Let’s take a look at what both scenarios look like in real life.

Shorting a Stock 📊

In early February 2022, AMD jumped from $114 to $130 in one day. Considering the hectic performance of tech stocks in Q1 2022, it is not strange that the markets saw this jump as the forming of a bubble. Naturally, when a bubble forms, everyone wants to short it before it pops—and that’s exactly what happened.

As the stock reached the $130 level, the price stagnated for a while before crashing down. However, we can see a very sharp spike in short interest just as the price was reaching its high, which means that the markets overwhelmingly thought that the bubble would burst, which it did.

In this scenario, looking at short interest would’ve given any trader a good indication to either short AMD using a put option or to at least wait for a while before buying. Moreover, in this particular case, analysis tools like the RSI and the MACD also indicated that the stock is overvalued—which is probably one of the things that prompted traders to take such heavy short positions.

All in all, short interest—along with a number of indicators—can give us a solid idea of whether a stock is overbought and due for a correction or not. However, simply jumping on the shorting bandwagon as a habit is not a good idea—huge short interest often triggers short squeezes which can make short sellers take heavy losses and should be avoided at all costs.

Short Squeeze 📈

Just a month after our first example, AMD short sellers had a pretty uninspiring couple of weeks. Namely, when the stock reached the floor of its usual trading range, short interest increased—traders were likely hoping that the price would keep going down due to strong downward momentum.

However, the opposite happened—the price just bounced back up after reaching its previous low point, which is typical for stable stocks. As the price dropped again afterward and reached the same price, short interest spiked again, and the stock bounced back up again, decimating short sellers’ positions.

Namely, AMC published its Q1 earnings report in March and completely surprised bearish investors with an impressive 71% growth in the first quarter. In this case, short sellers lost a lot due to the price increase as they got squeezed by a bullish market. This time around, trading the news was effective while longer-term fundamental and technical analysis led many short sellers to suffer great losses.

How to Calculate Short Interest 🧮

Even though it is easy to get calculated short interest data through any premium app for trading stocks, it pays to know how this simple formula works. First of all, short interest can either be expressed as an absolute value or as a percentage.

Since it is more common and useful to express short interest as a percentage of a stock’s float, we will examine that formula. Here it is:

The numbers of shorted shares that have not been covered includes all publicly known short positions, and share float is just the total number of publicly tradable shares. Divide one with the other, and we get a percentage—easy peasy.

Understanding the Short Interest Ratio 📘

Knowing how to calculate short interest is nice, but we can get even more useful info about a stock by calculating its short interest ratio as well. Namely, this formula calculates how many days short sellers would need to buy up the shares they need to close their short positions.

To get the short interest ratio for a stock, we simply need to take the number of shorted shares (short interest expressed in absolute numbers) and divide it by the average daily trading volume:

The short interest ratio is especially useful to traders looking for a short squeeze opportunity.  Namely, if the short interest ratio is high, a short squeeze is more likely—If the number of short positions is very large, short sellers will have a hard time buying shares at a fair price to close their positions.

In this case, short sellers have to limit the losses by buying the shares quickly at a price that’s available—and when they start buying en masse, they might pump the stock. Simply, a high short interest ratio means that the demand for buying a stock is very high—consequently, the price is likely to go up.

Short Interest vs. Call/Put Ratio ⚔

Both short interest and call-to-put ratio are measures of market sentiment. However, unlike short interest, the call-to-put ratio also measures positive, bullish sentiment—and this makes the latter seem like a superior source of information.

But, the call/put ratio only looks at open contracts in the stock options markets, completely ignoring shares that were borrowed by traders who are directly shorting securities without using derivatives. Therefore, the call-to-put ratio is useful because it tells us what percentage of the market is bullish, but short interest can give us a better overview of the bearish positions held against a certain stock.

Pros and Cons of Short Interest ⚖

As long as it is used responsibly, short interest can be a handy tool for determining if tension is building around a stock. By itself, short interest cannot help us predict whether shorting is a good idea or if a squeeze is coming—but it can tell us that something noteworthy will happen and that we should investigate further.

However, just looking at short interest data without using other analysis methods is very dangerous and may lead traders to jump on greed market bandwagons heading south (financially). All in all, short interest data would just be a single item in a trader’s toolbox, otherwise, it can lead to unfounded price predictions.

Conclusion 🏁

At the end of the day, short interest is just one of many tools necessary for making probable predictions and good trades. As an indicator, it simply doesn’t work on its own because a heightened short interest can be interpreted in many ways and caused by many factors.

However, simply looking at a stock’s short interest is a great way to quickly determine if a company is being targeted by bearish investors. If it is in the crosshairs and its short interest is high, a stock’s price can be influenced greatly in multiple directions, which makes this metric crucial for screening stocks and finding good shorting opportunities.

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“Invest spare change” feature

Value-based investing

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Rating

7.0/10 Visit Acorns on Acorns' website

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Fees

Account minimum

$0

$5 required to start investing

Starts at $3*

Minimum initial deposit

$0

$0 to open account

$0

Commissions

$0

$3 or $5/month

$0

General

Best for

DIY stock trading

People who struggle to save

New investors

Highlight

Pioneer of commission-free stock trading

“Invest spare change” feature

Value-based investing

Promotion

Free stock

$5 bonus¹

Rating

8.0/10 Visit Robinhood on Robinhood's website

7.0/10 Visit Acorns on Acorns' website

8.0/10 Visit Stash on Stash's website

About the author

Fabian Sandoval

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Fabian has more than 10 years of experience as a financial data analyst. He now focuses on writing, where he can share valuable insights from his experience with others.