What Is the Short Interest Ratio?
The Short Interest Ratio takes the number of shares held short in a stock and divides this by the stock’s average daily trading volume. Simply put, the ratio helps an investor quickly discern if a stock is heavily shorted compared to its average daily trading volume.
The term is sometimes used interchangeably with “days to cover.”
Key Takeaways
- The Short Interest Ratio is a quick way to see how heavily shorted a stock may be versus its trading volume.
- The Short Interest Ratio indicates how many days it would take for all the shares short to be covered or repurchased in the open market.
- Short Interest and the Short Interest Ratio are not identical—Short Interest measures the total number of shares that have been sold short in the market.
- News or events may impact trading volumes and make the ratio expand or contract, so it should always be compared with the actual Short Interest and trading volumes.
The Formula for Short Interest Ratio:
Short Interest Ratio = SI / ADTV
Where:
SI = Short Interest
ADTV = Average Daily Trading Volume
What the Short Interest Ratio Can Tell You
The ratio informs an investor whether the number of shares short is high or low compared to the stock’s average trading volume. The ratio can rise or fall based on the number of shares short; however, it can also increase or decrease as volume levels change.
Example of How to Use the Short Interest Ratio
Let’s consider a hypothetical example. If Company ABC has 500,000 shares sold short and its average daily trading volume is 2 million shares, the Short Interest Ratio would be:
Short Interest Ratio = SI / ADTV = 500,000 / 2,000,000 = 0.25
This implies it would take a quarter of a day to cover all the short positions, assuming constant trading volume.
The Difference Between a Short Interest Ratio and Short Interest
It is crucial to understand that the Short Interest Ratio and Short Interest are not the same. Short Interest measures the total number of shares that have been sold short in the market.
The Short Interest Ratio is a formula used to determine how many days it would take for all the shares short in the marketplace to be covered.
Limitations of Using the Short Interest Ratio
The Short Interest Ratio has several limitations, the first being that it is not updated regularly. Short Interest is reported bi-weekly and is usually as of the 15th and last day of the month. It takes several days before this information is published, and by that time, the number of shares short in the market may have already changed.
Additionally, one must consider how news or events may impact trading volumes, making the ratio expand or contract. The ratio should always be compared with the actual Short Interest and trading volumes to get the full picture.
By understanding and leveraging the Short Interest Ratio, investors can gain valuable insights into market sentiment and effectively tailor their trading strategies.
Related Terms: Days to Cover, Short Interest, Average Daily Trading Volume, Market Trends.
