What is the short interest ratio?

What is the short interest ratio?

The short interest ratio is a formula traders use to see how heavily a stock is being shorted and how many days on average it will take for all of the stock’s shorted shares to be rebought in the open market. It is calculated by dividing the current total number of shorted shares by the average daily trading volume of the stock.

The short interest ratio is often expressed as ‘days to cover’ or a ‘percentage of float’. Days to cover refers to how many days it will take for the shorted stock to be bought up, and a percentage of float indicates what percent of a company’s public stock is currently shorted.

Both expressions of the short interest ratio are calculated using the short interest, which represents the number of shares currently shorted in the open market. Be careful to not confuse the short interest with the short interest ratio.

What is shorting?

Before we get into more detail about the short interest ratio, let’s review what shorting is exactly. When shorting a stock, you are essentially borrowing shares from your broker and selling them on the exchange. If the shares price drop in price, you can then buy them back at a discount and keep the difference as profit.

FOREX.com allows you to short stocks with CFDs, which grants you the ability to trade without having to physically own the stock, eliminating the borrowing process when shorting. Trading CFDs allows you to open a position on margin and at a lower price than if you were buying the stock outright.

Learn more about going short with CFDs.

How to find and read the short interest ratio

The short interest ratio is calculated by taking the number of shorted shares for a stock and dividing it by the stock’s average daily trading volume.

Short interest ratio = short interest / average daily trading volume

As introduced above, the short interest ratio can be expressed as either the days to cover or a percentage of float. Both provide an idea of how shorted a stock is, but with varying considerations. Keep reading for examples of both. 

What is days to cover?

Days to cover refers to the number of days it would take for the entire short interest of a stock to be bought back. If it seems exactly like the short interest ratio, that’s because it is! The two are calculated the exact same way.

Days to cover example:

Days to cover = short interest / average daily trading volume

For example, if a company has 5 million shares sold short, and the average daily volume for the stock is 1 million, the short interest ratio as days to cover is 5 days.

Days to cover = 5 million / 1 million = 5 days

What is percentage of float?

Percentage of float is similar to the short interest ratio, but it instead divides the short interest by shares available to trade, also known as the public float.

The public float refers to the total number of shares available for trading, so the percentage of float denotes the number of a company’s public shares that are currently shorted without evaluating how many shares are traded daily.

Percentage of float example:

Percentage of float = short interest / public float x 100

If the public float of the previous example is 40 million, and 5 million of those shares are shorted, the short interest as a percentage of float is 12.5%.

Percentage of float = 5 million / 40 million x 100 = 12.5%

How to find a stock’s number of shorted shares

Financial regulatory bodies require all broker-dealers to report short interest data twice a month, although the exact days may vary among organisations like FINRA, the FCA and IIROC. Most stock exchanges also report short interest data once or twice a month.

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What is considered a high short interest ratio?

A high short interest ratio is generally 10% or higher as a percentage of float. Anything above 10% is thought to indicate a strong pessimistic attitude towards the stock’s future price action. A short interest ratio of 20% or more is extremely pessimistic.

As for days to cover, five or more days indicate a slightly pessimistic stance towards the stock, and ten days or more suggests extreme negativity by traders and investors.

What is a low short interest ratio?

A low short interest ratio is anything under 10% as a percentage of float, and one to four days to cover. These ranges indicate strong positive sentiment for the stock’s price to rise as so few traders are actively betting it will fall.

Example of how to use the short interest ratio

The short interest ratio is an easy snapshot of current market sentiment towards a stock. A higher short interest ratio can indicate the stock is faltering and not a good buy. Of course, this is up to your own interpretation because it could also indicate that the stock is at a bargain and primed to rally higher in the future.

You could also see how the short interest ratio trends over several months. If it is trending upwards, it may signal investors are beginning to lose faith in the company. If the short interest ratio is shrinking over time, it could mean the company’s public sentiment is strengthening.

Keep in mind the short interest ratio is not a perfect indicator of a stock’s future performance, but it can be a good place to start for traders evaluating stocks. Doing your own research into why the short interest ratio is where it’s at is necessary to make a final judgement before opening a position.

How to trade stocks

You can go long or short on hundreds of stocks with City Index in just four steps:

1. Open a City Index account, or log-in if you’re already a customer
2. Search for the stock you want to trade in our award-winning platform
3. Choose your position and size, and your stop and limit levels
4. Place the trade

Or you can try out your trading strategy risk-free by signing up for our Demo Account.