Investors short a stock when they think its price is about to tank. The short interest ratio is the number of shorted shares for a company divided by the stock’s average daily trading volume. Calculating the short interest ratio shows you the number of days it would take investors to close out short positions in the open market.
In this article, we’ll explain how short interest ratios work. We’ll walk you through a real example of a short interest ratio and explain how you can find the information you need to calculate it for any publicly traded company. Finally, we’ll discuss when and how you should use short interest ratios to make investing decisions.
Definition and Examples of Short Interest Ratio
The short interest ratio is a formula that you calculate by dividing the number of shorted shares for a stock by its average daily trading volume. The formula reveals how many days investors would need to repurchase the shares and close out their outstanding short positions.
- Alternate names: Short ratio, days to cover
- Acronyms: SIR, SR
To understand why this number is important, you need to know how shorting a stock works. When investors short a stock, they’re essentially borrowing shares from their broker and immediately reselling them in hopes that the price will drop. Investors with short positions can profit if the stock’s price falls because they can buy back the shares for a lower price and return them to their broker. The investor’s profit is the difference between the price of the original sale price and the price they paid to repurchase shares.
But if the stock rallies, you can theoretically lose an infinite amount of money if you have a short position because there’s no limit on how high share prices can rise. Because of the potential for large losses, short sellers prefer to be able to repurchase shares quickly to close out their positions. The higher the short interest ratio, the longer it will take for them to do so.
A high short ratio typically implies that investors are bearish or expecting the stock price to drop. Conversely, a low short ratio suggests they’re bullish.
How Short Interest Ratio Works
To calculate the short interest ratio, you need to know:
- Short interest: The total number of a company’s outstanding shares that have been shorted.
- Average daily trading volume: The average number of shares that are traded each day.
The short interest ratio formula is as follows:
Short interest ratio = Short interest / Average daily trading volume
Suppose investors have shorted 3,000 shares of Company ABC’s stock. The company’s average daily trading volume is 2,000.
Applying this formula to Company ABC, we get:
ABC’s short interest ratio = 3,000 shorted shares / 2,000 average daily trading volume = 1.5 days to cover
If short interest or the number of short positions in the stock were to double, the short interest ratio would double as well. Likewise, the short ratio would double if the number of shorted shares remained constant but average daily trading volume dropped by half.
For example, the short interest ratio for retailer Bed Bath & Beyond trended upward during the first five months of 2021. Nearly 75 million shares were shorted as of Jan. 15, 2021, while the average daily trading volume was just over 17 million, meaning the days-to-cover ratio was 4.4.
By mid-May 2021, the number of short positions had dropped to less than 33 million. But average daily trading volume dropped more than 80% during the same period to just over 3 million. As a result, Bed Bath & Beyond’s short interest ratio grew to 10.7. That means it would take 10.7 days to cover all short positions of the retailer’s stock, or an extra 6.3 days compared to mid-January.
The more days to cover, the more vulnerable a stock is to a short squeeze, which happens when traders inadvertently drive up a stock’s price in a rush to close out their short positions. A short ratio of seven days or more suggests that short sellers are likely to have difficulty closing out their positions.
Because shorted shares can be borrowed and shorted multiple times, it’s possible for short interest ratio to exceed 100%.
It’s relatively easy to find the information you need to calculate short interest. Under Financial Industry Regulatory Authority (FINRA) and U.S. stock exchange rules, brokerage firms must report short positions to FINRA twice a month. Platforms that provide real-time stock market information, like Yahoo Finance, make it easy to find information about short positions and trading volume when you search for a stock’s ticker.
Investors can also use short interest ratio as a gauge of whether the outlook for the overall stock market is bullish or bearish. The NYSE short interest ratio tells you the short ratio for the entire New York Stock Exchange. The NYSE publishes monthly short interest data for all of its indexes.
To calculate the short interest ratio, divide the number of outstanding shorted shares across the entire exchange by the average daily trading volume of the NYSE for the past month.
What It Means for Individual Investors
Short interest alone can provide valuable information about how other investors feel about a stock.
The short interest or short interest ratio does not dictate the actual movement of stock prices. A company with a high short interest may still be able to deliver positive returns.
It’s also important to keep in mind that short interest information can quickly become out of date, especially in a volatile market, since brokerage firms are only required to report this information twice a month.
The higher the short interest ratio, the greater the risk of taking a short position. If a stock’s price starts to shoot higher, investors who have shorted the stock typically want to be able to close out their positions quickly to minimize losses.
The short interest ratio can also give you important information even if you haven’t shorted a stock. For example, if you own stock in a company with a high short ratio, the share prices will theoretically increase during a short squeeze, and you’ll be able to sell at a profit. However, short squeezes are extremely difficult to predict. In the event that short sellers are correct in their bearish sentiment and the stock’s price tanks, you could lose significant money as a shareholder.
Individual investors should exercise caution before buying or shorting a stock with a high short interest ratio.
- To calculate the short interest ratio, divide the number of shorted shares by the average daily trading volume. The number tells you how many days it would take investors to close out short positions on the open market.
- When the short interest ratio is high, it suggests investors are bearish about a stock. If the short interest ratio is low, it implies that investors are bullish.
- The higher the short interest ratio, the more vulnerable a stock is to a short squeeze.
- FINRA and U.S. stock exchange rules require brokerage firms to report short positions to FINRA twice a month.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.