Why It's Important To Know And Understand Short Interest Data

It was legendary investor Jim Chanos who once said in a Bloomberg interview, “short sellers are the market’s real-time financial detectives."

And for all headaches short sellers (particularly activist shorts) may cause for company executives and board members, their role in identifying fraud and improving liquidity contributes greatly to making the market more efficient.

That’s because shorting represents the other side of the market. Knowing how much of the market is on the short side of a security can be a valuable piece of information. If a security has a lot of short activity, it may be worth it to try and figure out why.

There are a few ways we measure a security’s short activity:

• Short Interest: The total amount of shares that are currently sold short by short sellers
• Short Percent of Float: The percentage of a security’s available tradable shares that are sold short
• Days to Cover: The number of days, based on a security’s daily trading volume, that would be needed to cover all its short positions. The greater the days to cover, the greater the potential for a short squeeze (where shorts get pressured into buying back the security at a higher price)

It’s also important to pay attention to the percentage change of a security’s short interest, as that can tell us whether it’s becoming a more or less popular target by short sellers.

Short percent of float is perhaps the most important of these metrics since it puts short interest within the perspective of all the shares that can be traded. It’s a potential red flag when a security has a high short percent of float HEAR, which had a short percent of float of 61 percent as of the most recent FINRA short interest report).

Some short selling information is mandated. FINRA requires all member firms to report their total short positions in all customer and proprietary accounts on a bi-weekly basis. This allows the market to get a decent understanding of short activity.

However, unlike the long side of the market, where individual investors are required to disclose to the SEC if they’ve acquired at least a 10 percent stake in a company, short sellers have no such obligation. In some cases, influential short sellers will voluntarily disclose their short positions (in the hope that it drives the price down), but this is not a requirement. Many on Wall Street have lobbied to fill this blind spot, arguing it will bring more transparency to the markets.

Short interest data is always an important tool, regardless of the market. But with over 10,000 securities trading on the OTC Markets, many of which are primarily traded in other countries and by experienced professionals, it’s an especially valuable signal for gauging the market’s general sentiment on a given security.

OTC Markets is a content partner of Benzinga

Image credit: BagoGames, Flickr