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How to Read a Short Interest Ratio

Original post by Jonathan Langsdorf of Demand Media

The short interest ratio measures the ability of stock market traders to sell short in an attempt to profit from falling prices. A short sell is when an investor essentially bets against a stock, and involves borrowing to sell stock the trader does not own, then (ideally) buying it back at a lower price. To close the trade and realize the profit from a price decline, the trader must buy the shares back and return them to his broker. The amount of shares of a particular company that have been sold short is reported as the short interest and the short interest ratio.

Step 1

Select a source for short interest data. The two major stocks exchanges -- NYSE and Nasdaq -- publish and update short interest data twice a month. Short interest for Nasdaq stocks can be done on the exchange's website. The Wall Street Journal website and Yahoo Finance also provide short interest data for individual stocks.

Step 2

Look up the short interest ratio for a stock that interests you. The ratio may also be referred to as days-to-cover on the short interest data. The short interest ratio is the number of shares of the stock currently sold short divided by the average daily trading volume of the stock. For example, if 1 million share of a stock are currently sold short, and the average daily trading volume of the stock is 200,000 shares, then the short interest ratio of this stock is four.

Step 3

Analyze the short interest ratio to determine if the ratio indicates the share price will decline or could possibly turn upward. A large number of shares sold short indicates traders believe the stock will decline in value. The short interest is pent up buying demand for a stock because traders must buy the shares to close their short positions. The short interest ratio shows the number of days it would take for all of the short sellers to buy back the shares at normal trading volume for the stock.

Step 4

Compare the short interest ratio, total short interest and stock share price over a period of time. Changes in these values are also indications of where traders think the stock price is going. Traders looking for a stock that will soon turn upward may look for a stock with a rising short interest ratio. If the share price turns upward, the buying demand from short sellers can push the share price rapidly higher.

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Tips & Warnings

• The free short interest and short ratio data is only updated twice a month. Daily updates can be obtained from premium services for a monthly fee.
• Look up the short interest ratio for several stocks to get an idea of the range of values for this indicator. Look at stocks that have been going up in price and stocks in a downward trend.