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

In this article, we will discuss three key indicators commonly used to measure the level of short interest in a stock: short interest (as a percentage of a stock’s total amount of shares outstanding), short interest ratio (also known as days-to-cover and the short interest as a percentage of a stock’s total float.

Short Interest & Short Interest Ratio

I have determined the average short interest ranges for short interest and short interest ratio, which are shown in the table below (in the neutral column). This table also shows when I determine if a short squeeze is likely, categorizing the possible outcomes into low risk, neutral, and high risk. Naturally, 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.

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 a Percentage of the Float

To calculate short interest as a percentage of the float, divide the total number of shares short by the float, which is the total shares outstanding minus restricted shares, insider ownership, and shares owned by shareholders who own at least 5% of the company’s total shares outstanding. This ratio produces a higher outcome than the ‘standard’ short interest calculation because the same amount of shares short are divided by a smaller amount of shares, i.e., only those shares that are available for trading. Unfortunately, I could not determine an average short interest range for this ratio, so I have to assess each company individually to determine if a short squeeze is likely.

Comparing a Company’s Short Interest Indicators

Comparing a company’s short interest indicators with its indicators from the previous period can provide valuable market insights, especially when analyzing multiple periods. For example, if Company ABC’s short interest decreases by 10%, it means that Mr. Market is 10% less certain that the share price of Company ABC will decline. If 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 generally consider a decline in shares short for the stocks in my portfolio as a bullish signal, and vice versa.

However, a heavy increase in short interest can also be a bullish indicator because it may result in a short squeeze rally. A short squeeze rally may occur when the price of a company’s stock increases, resulting in a loss for short sellers, forcing them to cover their losses by buying back 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.

Note: Shorting a stock is further explained in the article: Short Stock Positions – How to Short a Stock and Where To Find Short Interest Data.

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 occur. Always complete your due diligence before deciding what to do with the specific stock on your radar.

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