What Is Short Interest, and Why Does It Matter to Traders?

What Is Short Interest?

Short interest is the number of shares that have been sold short and are still outstanding. Traders typically sell a security short by borrowing shares of the stock from their broker when they anticipate that the share price will decline. The investor then sells these borrowed shares to buyers willing to pay the market price.

Simply put, it's a measure of how many investors are betting that a stock's price will fall. This straightforward statistic can reveal a wealth of information about market dynamics and investor expectations. An increase in short interest often signals that investors have become more bearish, while a decrease in short interest signals that they have become more bullish.

Short interest is often expressed as a number or percentage. Below, we discuss how to use this statistic to your advantage while trading and why it's crucial to the wider market and regulators.

Understanding Short Selling

Before turning to short interest, it's important to review short selling itself. This is a trading strategy where investors borrow shares of a stock they believe will decrease in value, sell those borrowed shares at the market price, and hope to buy them back later at a lower price before returning them to the lender. Among the public, it's long been a vilified strategy since you're essentially betting against firms where people have jobs that support their families and communities. But it's a very common hedging strategy for institutional and retail investors alike.

Here's how it typically works:

1. An investor identifies a stock they believe is overvalued or likely to decline.
2. They borrow shares of that stock from a broker, often paying a fee for this privilege.
3. The investor immediately sells these borrowed shares at the present market price.
4. If the stock price falls as anticipated, the investor buys back the shares at the lower price.
5. The borrowed shares are returned to the broker, and the investor profits from the difference between the selling price and the buyback price, minus any fees.

For example, if investors short 100 shares of a stock at $50 per share and the price drops to $40, they can buy back the shares for $4,000, netting a profit of $1,000 (minus fees and any dividends paid during the short period).

Short selling is inherently risky because, theoretically, there's no limit to how high a stock's price can rise. If the stock price increases instead of falling, the short seller may face significant losses. This potential for unlimited losses makes short selling a strategy typically employed by more experienced traders or institutional investors.

What Does Short Interest Signal?

Short interest can clarify the potential direction of an individual stock, as well as how bullish or bearish investors are about the market overall. Stock exchanges measure and report on short interest each month, providing investors tools to use as a short-selling benchmark.

A large increase or decrease in a stock’s short interest from the previous month can reveal investor sentiment. For example, if the short interest for a stock rises from 10% to 20%, it may be a warning sign that negative sentiment is growing about the stock, as the number of investors who expect the stock price to decrease has doubled.

Short interest can also be converted into a ratio, also known as days to cover, by taking the number of short shares and dividing it by the average daily trading volume. The short-interest ratio tells you how many days it would take for all of a stock’s shares that are sold short to be covered or repurchased in the market.

For example, if short interest is one million shares and its average daily trading volume is 100,000 shares, it will take the shorts, on average, at least 10 days to cover their positions.

How Is Short Interest Determined for a Company?

Short-interest information is typically reported biweekly by stock exchanges and can be found on financial platforms and FINRA's website. Once you have the number of shares sold, you can calculate the short interest as a percentage of the company's total outstanding shares. The formula for the short-interest ratio is as follows:

Short Interest (%) = (Shares Sold Short / Total Outstanding Shares) × 100

Short Interest Ratio

Market participants use the short-interest ratio to check the potential for a stock's price movement based on the level of short-selling activity. This ratio is calculated by dividing the total number of shares sold short by the average daily trading volume. The formula is as follows:

Short Interest Ratio = (Total Number of Shares Sold Short) / (Average Daily Trading Volume of Stock)

The ratio indicates the number of days it would take for all short sellers to cover their positions, assuming the average daily trading volume remains constant. The short-interest ratio gives insight into the market sentiment and the potential for price volatility.

Days to Cover

Market participants tend to use the short-interest ratio and the days to cover interchangeably. In fact, the formula for days to cover is the same as the short interest ratio.

How To Use Short Interest

If a stock has a rising level of short interest, this doesn’t mean that the stock will decline; only that a high number of investors are betting on a decline in price. An investor can calculate short interest or short float for a stock by dividing the number of shares sold short by the float, which is the total number of shares available for the public to buy.

If a company has 10 million shares of stock outstanding and 1 million shares are sold short, the total short interest is 10%.

Short interest can be used to indicate market sentiment for a company’s stock or the market as a whole, and some bullish investors see high short interest as an opportunity. However, there are some drawbacks to using short interest. Short interest reports, such as those provided monthly by the New York Stock Exchange (NYSE), are not timely and may not reflect current market conditions. Also, stocks can be heavily shorted for a long period without leading to a short squeeze or a price decline.

Examples of Short Interest Ratio

A notable real-world example of short interest increasing for a stock is Tesla (TSLA) in early 2020. At that time, Tesla's stock price was in the midst of a years-long surge, which attracted a large number of short sellers who believed that the stock was overvalued. As Tesla's price climbed to new highs, its short interest also increased sharply. By mid-February 2020, Tesla's short-interest ratio had risen to being the most in the market, signaling growing bearish sentiment among investors. The days-to-cover ratio, which measures the number of days it would take for short sellers to cover their positions based on average daily trading volume, also increased.

Soon afterward, Tesla's stock price suddenly declined as broader market concerns, including the impact of the COVID-19 pandemic, led to a market correction. However, the short interest continued to drop during the year as short sellers had to get out before they took on even more losses. The pessimism of short sellers was costly. By the end of the year, they were out about $40 billion.

Several years later, the market had another prominent example of a highflying stock being widely shorted. C3.ai (AI), a company focused on artificial intelligence, dramatically increased short interest throughout the year. The percentage of C3.ai’s float shorted rose from 9.2% after the New Year in 2023 to 38.2% by Dec. 11, 2023. This substantial increase in short interest indicated that many investors were betting against the stock, driven by concerns about intensifying competition in and the company’s ability to maintain its market position.

The days-to-cover ratio for C3.ai peaked at 6.86 in November 2023, highlighting the stock’s vulnerability to a short squeeze—a situation where short sellers are forced to cover their positions quickly, driving the stock price up sharply. The high short interest ratio and a rising days-to-cover metric made C3.ai's stock highly volatile during this period, with the potential for significant price swings, which were still occurring in 2024.

Short interest within the S&P 500 index can serve as a critical indicator of market sentiment, revealing the stocks most heavily bet against by investors. In the index, the stocks with the highest short interest typically reflect a strong bearish outlook from the market, often because of concerns about the company's future performance, competitive pressures, or broader industry challenges. Meanwhile, those with the lowest short interest may indicate investor confidence, stability, or even potential underestimation of risks by the market.

The table below shows the highest and lowest percentages of short interest in the S&P 500 in August 2024. A high short-interest ratio like the one for KMX suggests that many market participants are positioned for a decline in the stock's price, which could indicate bearish sentiment. However, it also raises the potential for a short squeeze. On the other hand, a low short-interest ratio, similar to TFX, may indicate a lack of bearish sentiment and a lower potential for a short squeeze, making the stock less likely to experience sudden, sharp price movements. Both shares have a high float, meaning more than enough shares are available for trading.

FINRA's Short Interest Reporting Requirements

FINRA mandates that firms report their short interest positions twice a month for all customer and proprietary accounts across all equity securities. The reporting must be completed by 6 p.m. Eastern Time on the second business day after the settlement date.

These requirements ensure transparency and help regulators and others monitor the market. Here's a short summary of FINRA's rationale for its reporting requirements:

The Bottom Line

Short interest reveals how many shares of a company are sold short and not yet covered. Short interest is often expressed as a number, yet it is more telling as a percentage.

An increase in short interest often signals that investors have become more bearish, while a decrease in short interest shows they have become more bullish. Short interest can be used as an indicator of market sentiment for a company’s stock or the market as a whole, and some investors use this as a sign that it's going to be profitable to short that company’s stock.