Short Interest Ratio Explained: Define, Calculate, and Analyze Its Impact

What Is the Short Interest Ratio?

The short interest ratio measures market sentiment by comparing shorted shares to average daily trading volume. It's calculated by dividing shares sold short by average daily volume. The short interest ratio isn't always timely because it uses bi-weekly reports; it's crucial to check it with real-time data. In addition, the short interest ratio can change due to fluctuating trading volumes and the number of shares shorted. It's a useful tool, but investors shouldn't rely on it without considering other indicators and live market data.

Calculating the Short Interest Ratio: A Step-by-Step Guide

$\begin{aligned}&\textbf{Short Interest Ratio}=\frac{SI}{ADTV}\\&\textbf{where:}\\&SI= \text{Short Interest}\\&ADTV = \text{Average Daily Trading Volume}\\\end{aligned}$​Short Interest Ratio=ADTVSI​where:SI=Short InterestADTV=Average Daily Trading Volume​

1. Identify the Short Interest (SI) – This represents the total shares sold short. 
2. Determine the Average Daily Trading Volume (ADTV) – Find this by looking at recent trading history. 
3. Use the formula: Short Interest Ratio = SI / ADTV – Divide SI by ADTV to find the ratio. 

Interpreting the Short Interest Ratio for Market Insights

The ratio shows if the number of shorted shares is high or low compared to average trading volume and can change with shifts in shorted shares or trading volume.

Real-World Example: Understanding Short Interest in Practice

The Tesla chart below shows the short interest ratio, the number of shares short, and the daily average trading volume. In the example, one can see that a rising short interest ratio does not always correspond to rising short interest.

In July and August 2016, the ratio rose as average volume fell, though shorted shares decreased. In 2018, short interest was high but declined, as daily volume increased..

Short Interest Ratio vs. Short Interest: Key Differences Explained

Remember, the short interest ratio and short interest are different. Short interest measures the total shorted shares in the market.

The ratio measures how many days it would take to cover all shorted shares.

Limitations of the Short Interest Ratio: What Investors Should Know

The short interest ratio has several flaws, the first being that it is not updated regularly. Short interest is reported every two weeks and is usually as of the 15th and the last day of the month. It takes several days before the information is published and by that time, the number of shares short in the market may have already changed.

News or events can affect trading volumes, expanding or contracting the ratio. Always compare the ratio with actual short interest and trading volumes for a full picture.

The Bottom Line

The short interest ratio is used to see if a stock is heavily shorted compared to its average daily trading volume, essentially showing how many days it would take to cover all short positions. Unlike short interest, which only gives the raw number of shares sold short, the ratio adds context by tying it to trading activity. However, it does have drawbacks, such as lagging updates, and sudden market movements that can make the numbers less reliable. Bear in mind that while a high short interest ratio may indicate bearish sentiment, external factors such as news events can significantly impact the index’s reliability. It's a good idea to use the short interest ratio with other financial metrics and market analyses.