Definition: The Magic of Short Interest



Short Interest is a term that refers to the number of shares of a particular stock that have been sold short [unowned shares sold with the expectation of reourchasing the sahres at a lower level for profit] but not yet repurchased or covered. It can be expressed as an absolute number or as a percentage of shares outstanding. Short interest is often used by traders to help determine the prevailing market sentiment toward a stock. An increase in short interest often signals that traders have become more bearish, while a decrease in short interest shows that they have become more bullish.

How Does Short Interest Work?

While the above is the general view with respect to Short Interest, there are times when high Short Interest is seen as potentially bullish rather than bearish. For example, if a significant % of the shares outstanding of stock A is sold short, and the market perceives a bit of news or information that leads to a change [positive] in the perspective of traders. That sudden change leads to demand outstripping supply which then leads to high Short Interest acting like jet fuel propelling shares higher as traders who are short scramble to buy back their shorts and end their losses/prevent further losses. The rationale is that if everyone was selling/has sold, then the stock was already at its low and could only move up as opinions are suddenly more positive leading to more demand.

Translation

High short interest can lead to an extended and extreme rally when short sellers are caught in an up draft in prices but “everyone” is short because of the circumstances mentioned above.

For example, Stock GSIT [shown above] has been trending down for many months. On Friday the stock rallied more than 200%... in a single trading session. And traded more than 60 times the average daily volume of 1.7 million shares.

I imagine that quite a few folks went to bed happily short GSIT on Thursday night before waking up and needing to contend with a stock that was rallying against them.

As I mentioned above, the mechanics of runaway rallies like this are simple. Something sparks the purchase of a stock and pushes it higher. That move spurs other shorts to “cover” their short positions and before long there’s a wealth of buyers… and no sellers.

Result? A parabolic rally.

Hope it helps.