Short Interest Ratio

Selling short - When the investor who do not have stocks but borrows them and sell them in the market. it's becoming increasingly popular among individual investors. Why investor sell short? because the nvestors decides that all signs point to a decline in the stock price rather than an increase. So the investor borrows shares of the stock at that price and immediately sells them. After the stock falls, he buys it back on the open market to repay his debt. But since the price is lower, he pockets the difference.

A higher short interest ratio indicates more pessimism, because a higher proportion of a company's total float has already been sold short. It should always be treated as a red flag. But high short interest doesn't necessarily mean you should avoid the stock. After all, short sellers are very often wrong.

The short ratio (or short interest ratio) is usually the number of shares outstanding of a publicly traded company that is sold short, divided by the average daily trading volume. It can also be the percentage of the free float that is "shorted". The short-interest ratio tells you how many days -- given the stock's average trading volume -- it would take short sellers to cover their positions if good news sent the price higher and ruined their negative bets. The higher the ratio, the longer they would have to buy -- a phenomenon known as a "short squeeze" -- and that can actually buoy a stock. Some people bet on a short squeeze, which is just as risky as shorting the stock in the first place. Our advice is this: Use the short-interest ratio as a barometer for market sentiment only -- particularly when it comes to volatile growth stocks.

The short interest and short ratio can be deceiving, however, when a company has many convertible securities outstanding and is perceived to be at risk, because convertible and options arbitrageurs will often sell the stock short to manage risk with their long positions in these other instruments.

Technicans (Technical Analysts) interpret this ratio contrary to one's initial intuition. Because short sales reflect investors' expectations that stock prices will decline, one would typically expect an increase in the short-interest ratio to be bearish. On the contrary, technicans consider a high short-interest ratio bullish because it indicates potential demand for the stock by those who previously sold short and have not covered the short sale.

A technician would be bullish when the short interest ratio approached 5.0 and bearish if it declined toward 3.0.

Convertible hedgers are usually not hoping the price of shares will fall and, if properly hedged, can cover their short positions with shares embedded in the convertible securities. Thus, a large short interest position for such companies does not necessarily imply a classic short squeeze, and the short interest ratio becomes somewhat meaningless.

There are entire companies devoted to selling stocks short and they make it their job to seek out companies that are in trouble. They pore over financial statements looking for weaknesses. But sometimes they merely think a company is too highly priced for its own good.