Theoretical Aspects of Short Interest
What ist the Short Interest?
This is the number of shares currently borrowed by short sellers for sale, but not yet returned to the owner (lender). Every short seller anticipates a declining stock market. A profit is made if the stock is bought back at a lower price than when it was sold short. When a large amount of short selling activity is occurring, market participants obviously expect prices to head lower. Short sellers are potential buyers sooner or later and represent a lot of buying power when they have to scramble for cover in a sudden market turn.
Short Interest Theory
This is the theory that a large short interest is the predecessor of a rise in the price of a stock. The reasoning behind this is that the short positions must eventually be covered, which means that there will be more purchasers of the stock who in turn drive the price up. If a stock's price begins to rise significantly, investors who have short sold the stock will quickly begin to close out their positions (by purchasing shares off the open market), creating buying pressure for the stock and driving the price up even more. If a previously lagging stock turns very bullish, the buying action of short sellers can result in extra upward momentum and increased losses for short sellers who are slow to close out their positions. The longer the days to cover, the more pronounced this effect can be.
Short Squeeze
A short squeeze occurs when short sellers are scrambling to replace their borrowed stock thereby increasing demand and decreasing supply, forcing prices up. Short squeezes tend to occur more often in smaller cap stocks, which have a very small float (supply), but large caps are certainly not immune from this situation.
Short Interest Ratio
The short interest ratio is the number of days it would take to cover the short interest if trading continued at the average daily volume for the month. For example, if a company has average daily volume of 1 million shares and 2 million shares are currently short sold, the shares have a cover rate of 2 days.
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