Shorting a Stock – How I Determine if a Short Squeeze is Likely

Shorting a stock is explained in the article: Short Stock Positions – How to Short a Stock and Where To Find Short Interest Data. In this article, I refer to three key indicators that are commonly used to measure the level of short interest in a stock: the short interest (as a percentage of a stock’s total amount of shares outstanding), the short interest as a percentage of a stock’s total float and the short interest ratio, also referred to as days-to-cover.

For the short interest and for the short interest ratio, I have determined the average short interest ranges, which are shown in the table below (in the neutral column), and explained in the article about Short Stock Positions mentioned above. In this table you can also see when I determine if a short squeeze is likely, by subdividing the possible outcomes in the following categories: low risk, neutral and high risk. Logically, when a stock’s short position is rated as high risk, a short squeeze is more likely compared to stocks with a low risk rating. The higher the outcome of the ratio’s, the more likely it is that a short squeeze can happen.

Short Interest Indicators  Calculation  Low Risk  Neutral  High Risk 
Short Interest  (Shares Short / Shares Outstanding) x 100%  < 2% 2% – 3% > 3%
Short Interest Ratio  Shares Short / Average Trading Volume Last 30 Days  < 4  4 – 6  > 6 

Short Interest as Percentage of the Float

The short interest as percentage of the float is calculated by dividing the total amount of shares short by the float (i.e. the total shares outstanding minus the restricted shares, the insider ownership and the shares owned by shareholders who own at least 5% of the company’s total shares outstanding.).

The outcome of this ratio will be higher than the outcome of the ‘standard’ short interest calculated above, as the same amount of shares short are now divided by a smaller amount of shares, i.e. only those shares which are available for trading. Unfortunately, I was not able to quantify an average short interest range for this ratio, so I have to assess each company individually to determine if I believe a short squeeze is likely.

Comparing a Company’s Short Interest Indicators

Comparing a company’s short interest indicators with it’s indicators of the previous period, will lead to very helpful market insights, especially when you include more periods in this short stock analysis. For example, when Company ABC’s short interest decreases by 10%, it means that Mr. Market1 is 10% less certain that the share price of Company ABC will decline. When you see a 10% decrease in the previous period as well, you may assume that the sentiment in this stock is getting less and less pessimistic. Therefore, I normally consider a decline in the shares short for the stocks in my portfolio as a bullish signal, and vice versa.

However, a heavy increase in the short interest can be a bullish indicator too, as it may result in a short squeeze rally. A short squeeze rally may happen when the price of a company’s stock increases, which results in a loss for the short sellers, forcing them to cover their losses by buying back the shares in the open market to minimize their losses. This extra demand for the shorted stock leads to a further share price increase, which can lead to more short sellers covering their short positions, etc.

Cautious Note: Even if the outcome of the short interest indicators suggest a short squeeze is likely, it’s is never a guarantee that the short squeeze will actually take place. Always complete your due diligence as a whole before you decide what to do with the specific stock on your radar.

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