Short interest is an interesting indicator. Technically, it's a technical indicator because it is based on trading action (instead of the companies fundamental/financial health).
Unlike most technical indicators, short interest does not require much math. But it's data is widely and easily available online so investors usually overlook it.
Checking this number only takes a few seconds. And those few seconds can save you a boat load of time and money by telling you how bullish or bearish people are feeling.
Short Interest: What is It?
Short interest is the total number of shares of a stock that traders and investors have sold "short". It indicators the number of people who think a stock is going to fall in price.
How to Calculate It
Short interest is usually expressed as a percentage. You divide the number of shorted shares by the number of outstanding shares.
For example, if stock XYZ has 1,000,000 shares shorted, and a total of 10,000,000 shares outstanding, then XYZ has a short interest of 10% (1,000,000 / 10,000,000).
How to Interpret It
When a stock's short interest increases, it means that there are a growing number of people who think prices will fall, and are therefore attempting to profit from a drop in share price.
When a stock's short interest decreases, it means that there are fewer people trying to profit from a drop nin share price.
A decreasing level of short interest does not mean the stock will rise. It only means that fewer people think it will fall. The price could remain flat...
How to use It
As mentioned above, short interest is one way to gauge how investors feel about a certain stock.
You can watch the changes in short interest over time to figure out how sentiment is changing.
When you see a shift in either direction (increases or decreases in the percentage), it is time to do some digging and figure out what may be headed your way.
Are the fundamentals getting worse? Is the sector weakening? Is the general market headed for a correction?
The Bottom Line
Short interest is a quick way to gauge how negative investors feel about a stock. A stock with a high level of short-interest does not need to be avoided, as short sellers can be wrong.
Instead, think of this indicator as a yellow light.