Short Interest: What It Is, How It Works [With Formula]

What is short interest?

Short interest refers to shares that have been sold short but not yet covered or closed out, and it is reflected as a percentage of the outstanding shares or the float. It is also possible to analyze short interest based on how many shares are short. However, this is not as useful without knowing all the shares the company has outstanding or the stock’s float. 

How short interest works

Short interest shows investors how the market views a specific stock and how many people are trying to short it. When investors have a negative view of a specific company, they will short the stock, which will be reflected in its short interest.

Therefore, if most investors think the stock will go down, the short interest will be higher. Conversely, if investors are optimistic about the stock’s price, the short interest will be lower.

High short interest can also result in abrupt price changes and increased volatility. If a stock with high short interest starts to move higher, investors who are short the stock will cover it which will drive the price even higher. To cover, they will have to repurchase the shares, which forces the price to move higher, and at the same time, attracts other short sellers looking to short the stock.

Significant changes in the short interest also serve as warning flags since they indicate that investors are becoming more bearish or optimistic about a company’s future outlook.

What short interest tells investors

Short interest can help investors understand the market sentiment towards a stock and how the stock is expected to move. The short interest will be low if most investors are bullish on the stock. Conversely, if the short interest is high, then it means that most investors are bearish on the stock and expect its price to decline.

For this reason, short interest is used by investors and traders to understand the market sentiment of a particular stock. Short interest is quantified and reported by stock exchanges and can be a helpful indicator for both investors and traders alike. Typically, they publish reports at the end of each month, providing investors with a benchmark for short-selling. Each month, the Nasdaq exchange provides a report on short interest. 

A significant increase or reduction in short interest in a company over the previous month may be particularly suggestive of sentiment. For instance, when short interest in stock increases, Mr. Market’s opinion toward the company deteriorates. 

Such a significant movement may prompt investors to conduct more research on the stock to find out precisely what is driving the bearish sentiment.

• Short interest measures the number of shares of a company currently being sold short and has not been covered.
• While short interest is frequently expressed as a number, it is more informative when expressed as a percentage, either of the float or the outstanding shares
• Short interest is a sentiment indicator: a rise in short interest frequently indicates that investors have grown more bearish. In contrast, a reduction in short interest indicates that investors have become more bullish
• Stocks with a high level of short interest may be considered a bullish indicator by contrarians looking for short-squeeze stocks

How to calculate short interest

There are a few ways investors can calculate the short interest that vary depending on the number of shares you want to divide by. 

Short interest formula based on float 

Short interest, based on the float, gives investors an accurate picture of the impact on the shares available to be traded. 

Short Interest as a % of Float = Number of Shares Short / Number of Shares in the Float

Short interest formula based on shares outstanding

It can also be assessed based on all of the shares that the company has. Although it gives investors a broader picture, the importance of this formula depends on how large the float of the stock is relative to its outstanding shares.

Short Interest as a % of Shares Outstanding = Number of Shares Short / Number of Shares Outstanding

Short interest ratio

A helpful measure, in this case, is the short-interest ratio. The short-interest ratio allows investors to understand how many days it will take for short sellers to cover their positions. By dividing the total number of shares that are short by the average daily volume of that particular stock. 

This way, investors can calculate approximately how many days it will take for all the short sellers to cover their shorts.

Short Interest Ratio = Number of Shares Short / Average Daily Trading Volume

How does short interest relate to short squeezes?

Stocks with high levels of short interest are more prone to short squeezes. Stocks with lower floats and a high level of short interest are more likely to experience a short squeeze as the number of shares available to short is lower. 

A short squeeze is an upward price movement induced by investor buying, combined with short sellers being forced to buy to avoid significant losses.

When analyzing a potential short squeeze, using the short interest ratio is beneficial. This is because it tells investors how many days, on average, it will take for short sellers to cover. The more days, the more impactful the covering volume will be on the stock price if there is a sudden movement upwards. The longer the days to cover, the more negative investors are.

Limitations of using short interest

While short interest might be informative and beneficial, it is not the primary determinant of investment decisions. Although it is a valuable metric to evaluate the market sentiment toward a stock’s future outlook, it should not be a decisive criterion when making investment decisions. 

It should be a piece of information to include in an investor's overall analysis. Adjustments in short interest, even extremes, may not immediately result in significant price changes. This is because short sellers may not cover their position right away.

As a rule of thumb, investors should view the short interest as an assessment of the sentiment towards the company’s stock and adjust that information into their analysis. It is also important to note that a high short interest does not directly mean that the stock will have abrupt movements.

Short interest based on float

There is no doubt that short interest is a valuable metric for investors. However, it is essential to use it properly so you do not jump to conclusions. For example, short interest, as a percentage of the float, should be carefully analyzed based on the float of that stock. 

If the float is a relatively low percentage of the shares outstanding, the short interest of the float will be more impactful. The opposite happens when the float is a large percentage of the shares outstanding. It is essential to analyze the data carefully and not focus only on the short interest.

What is considered a high or low short interest?

Low short interest

Low short interest is when there are no shares short, and this is highly uncommon across most markets and for most stocks. However, short interest on the float of under 5% is often considered low. 

It is usually a sign that the overall market sentiment is highly positive. The lower the short interest, the more positive the overall market outlook toward that stock. 

High short interest

Although there is some debate as to what level of short interest could be considered high, there are a few levels that may be considered high. It is dependent not only on the stock but also on the market and its participants. 

Nevertheless, when 10% or more of the shares are short relative to the float, it is a sign that there is high short interest. 

Is short interest bullish?

While short interest is a simple measure of the number of shorted shares relative to the company's float or outstanding shares, it can also be a bullish signal for investors. On the one hand, a stock with a low short interest can be bullish because if investors are not actively looking to short the stock, the overall market thinks the stock will move higher.

On the other end of the spectrum, highly shorted stocks with high short interest can be potential short squeezes. In this type of situation, a stock can experience a significant upward swing fueled by short sellers covering aggressively, as traders and investors also buy to push the stock price higher.