How To Use The Short Interest Ratio

The short interest ratio like the put to call ratio is used to gage market settlement. It allows you to understand where other people believe the market will go.

It takes into consideration how many people are short the market at any given time vs. how many shares are traded daily. The formula looks like this.

(Number of Shares Sold Short)/ (Average Daily Volume)

For example if there were 20,000,000 shares shorted and the daily average volume was 19,000,000 the short interest ratio would be 1.05.

This ratio is also called the days to cover ratio because it is said to represent how many days it would take for all of the short positions to be closed. So in this case if something happened and the stock started moving up it would take 1.05 days for all of the shorts to be covered.

There are other ways this ratio can help.

1. Finding bearish stocks

2. Deciding if a stock is oversold

3. Short Squeeze

Finding Bearish Stocks

When there are more and more people shorting a stock it means that the market sediment for that stock is turning bearish. Of course under no circumstances should you ever use it as a sell signal, but it can help you find down trending stocks.

Deciding if a stock is oversold

If a stock has too many open short positions you might want to think twice about opening another large short position on it. If you open too large of a short position on a stock that has already been widely shorted you might get caught up in a short squeeze.

Short Squeeze

Too many open short positions on a stock can also be a very bullish sign. What can happen is a scenario where everyone borrows stock and sells it on the open market in hopes of buying it back at a cheaper price sometime in the future.

Then the stock starts heading up. Everyone who entered a short position jumps in to buy stocks to cover their position. This in turn puts a lot of bullish pressure on the stock and forces it higher.

That can be very bad if you where short because you may get filled at a much higher position then you would have liked. But if you were long it can be very profitable.

How To find it

Each index keeps track of their shorts and displays the results at the end of the month. The NASDAQ has a short interest calculator which can give you the day to cover ratio for all stocks in the NASDAQ exchange.