What is Short Interest?
Short interest in a stock describes the number of shares that have been sold short but have not yet been covered or closed out. A high short interest position shows investors/traders are pessimistic about the stock and expect the stock to decline further.
NYSE and Nasdaq exchanges publish short interest reports. Twice per month by the Nasdaq and once per month by NYSE.
What is a Short Squeeze and Short Covering?
When a stock has an unusually high level of short positions, it can result in a short squeeze. A short squeeze occurs when a heavily shorted stock suddenly jumps sharply higher. The rising price forces traders who have shorted the stock to buy back the borrowed securities to close out an open short position. As they scramble to buy back or short cover their positions, this adds to the upward pressure on the stock's price. Some refer to this added buying pressure as the double demand theory.
Contrarian Sentiment Indicator?
Short interest can be a useful sentiment indicator. Opportunistic traders and investors often analyze short interest statistics to gain insights into extreme stock conditions. An increase in short interest positions may signal bearish conditions, while a decrease in short interests may signal bullish conditions. Stocks with extreme levels of short interests, however, can be contrarian buys and short-squeeze candidates.
There are several limitations to the short interest analysis. Since the reporting of short interest positions occurs either once or twice every month, the changes to these positions may not be timely. The current and actual short interest position may differ dramatically from the prior report. Also, a stock can remain at extreme readings (high short interests) for an extended period without triggering a short squeeze.
Short Squeeze News
Articles on short squeeze and how hedge funds have been hurt by these short positions have appeared in the press and media. GameStop Corp. (GME) is the latest example of a heavily shorted stock that suddenly reversed direction as the game retailer spiked higher in what appears to be a short squeeze. Melvin Capital Management, a well-known Hedge Fund, incurred heavy losses due to the GME short-position and has now taken on bailout funds from two other hedge funds.
During 2020, US short sellers suffered massive losses of close to $350 billion in net market-to-market losses. The largest losses occurred in the consumer discretionary and technology sectors. You can thank the easy FED monetary and the massive fiscal stimulus programs for injecting liquidity into the financial system.
The largest individual short interest positions at the end of last year (12/31/2020) were LGND (9.98 million shares shorted and 64.7% of float), BBBY (72.77m shorted/61.2%), SPWR (41.14m/50.7%), BYND (13.53m/37.6%), M (107.93m/35.1%), DISCA (107.93m/34.1%), JWN (35.47m/32.4%), OLLI (11.65m/24.2%), MTCH (12.19m/22.1%), and VIAC (114.75m/21.2%).
Technical Perspective on Short Squeeze/Short-Covering
Technically speaking, short squeeze or short-covering rallies are common practices in the stock market. It represents profitable trading opportunities for experienced and disciplined traders and investors. Typically, short-squeeze stock candidates tend to be out of favor names with extreme short positions that have declined precipitously from their respective highs. The key to successfully trading these stocks is to look for stocks that have recently suffered significant price declines and preferably experienced selling exhaustions/selling climaxes. Technical basing patterns such as a head/shoulders bottom, saucer bottom, large sideways rectangle pattern, or various technical bottoming formations are also helpful. Typically, the bigger the technical base (duration and size), the greater the chance for higher price appreciation when the short squeeze occurs.