Despite the Omicron variant sparking new COVID worries, supply chain issues, and other investing risks, stocks are trading near their all-time highs. Is investor sentiment truly this bullish?
When it comes to assessing market sentiment, you might consider adding a few indicators. Here's a technical indicator to add to your research arsenal: short interest. Short interest is at 2021 lows, suggesting investor sentiment is positive.
What is short interest?
Short interest is the number of shares of a particular stock that have been shorted. An investor who is short may potentially profit if the price declines. It can be considered bearish for a stock to have high or rising short interest.
Short interest is commonly expressed as a percentage—the number of shares sold short divided by the total number of outstanding shares. Suppose there are 10 total outstanding shares of a hypothetical stock. If one of those shares is sold short, the short interest as a percentage of outstanding shares will be 10% (1 ÷ 10 = 10%).
Short interest can also be applied to an index, such as the S&P 500 (or a comparable benchmark), to provide a sense of bearish sentiment for the broad market. The short interest chart below of the SPDR S&P 500 ETF Trust (SPY), which attempts to track the performance of the S&P 500, demonstrates how short interest has generally trended lower over the last year.
This version of short interest (short interest as a percentage of the total float, represented by the green line in the chart) has declined since a spike in February and is now near 2021 lows. This might be interpreted as investors broadly feeling confident about the market’s future prospects. Alternatively, contrarians might interpret low levels of short interest as complacency among investors and a reason to be bearish.
While you can get a general sense of investor sentiment using short interest as applied to an index or comparable security, this measure is more commonly used for individual stocks. If a relatively large percentage of short interest exists relative to similar stocks or to the stock’s own historical levels, it may indicate that sentiment is generally pessimistic for the stock. For example, if stock A and stock B operate in the same industry, and stock A has short interest of 20% while stock B has short interest of 5%, based only on this indicator, market sentiment for stock A may be considered more bearish.
You can find short interest data on the quote page for stocks and ETFs on Fidelity.com, including short %, total shares short, short interest ratio (days), prior shares short, and prior short interest ratio (days).
Why you might care about short interest
As with most technical indicators, short interest is not meant to be used in isolation. Rather, investors can use short interest to quickly compare sentiment between stocks and allow for the evaluation of the trend in sentiment for any single stock as well.
Of course, the amount of short interest does not dictate how a stock will perform. Many companies that have a relatively high amount of short interest can exhibit positive returns.
Moreover, short interest can be a double-edged sword. Consider the so-called short squeeze, which occurs when the price of a stock with a relatively high amount of short interest increases at an unexpectedly fast pace. If the stock is consistently moving higher, and short sellers no longer believe it will decline in price, they may decide to cut their losses and close out their short positions by purchasing the stock. This action can result in temporarily “squeezing” the price higher. If you have a short position (which is a risky strategy in and of itself because the potential loss is theoretically unlimited), the potential for a short squeeze is an even bigger risk to consider.
Many traders will also look at "days to cover" to evaluate a stock’s short interest. Days to cover is short interest divided by average daily volume. This can be important because it attempts to measure how long it may take to close out short positions and, consequently, the potential price impact of a short squeeze.
In sum, short interest can serve as another piece of information to assess a potential investment. You should not invest based solely on short interest; however, you can use it to help assess sentiment for a particular investment.