Mastering Short Interest: Trading Strategies and High-Potential Opportunities

Did you know that in 2020, short sellers lost over $38 billion betting against Tesla? This dramatic example underscores the power of short squeezes—opportunities that traders and investors alike strive to capitalize on.

An important metric in finding short squeeze setups is the Short Interest Ratio. In recent years, it has gained widespread attention among traders and investors, especially following the dramatic events of the "meme stock" phenomenon.

Stocks like GameStop and AMC Entertainment became headline news as surging prices caused a cascade of short squeezes, leaving traders searching for ways to capitalize on similar opportunities.

Short Interest Explained

• Short interest is a financial metric that measures the total number of shares of a stock that investors have sold short but not yet covered or closed out.

• It reflects market sentiment about a stock's potential future performance and can provide insights into investor expectations and potential price volatility.

The Concept of Short Selling

To grasp the concept of short interest, it’s essential to understand short selling.

Short selling is a trading strategy where an investor borrows shares of a stock and sells them on the open market, aiming to buy them back later at a lower price. The difference between the sale price and the repurchase price represents the trader's profit (or loss).

It is often used when traders anticipate a decline in the stock's price, making it a bet against the company. However, it carries significant risks, including unlimited losses if the stock price rises.

Why Short Interest Matters

Short interest serves as a barometer of market sentiment:

Bearish Sentiment: High short interest often indicates that many investors expect the stock’s price to decline.

Potential for a Short Squeeze: If a heavily shorted stock starts to rise in price, short sellers may rush to cover their positions, driving the price even higher.

Market Sentiment Dynamics: Extreme short interest levels, whether high or low, can reflect broader market or sector-specific trends.

How Is Short Interest Measured?

Short interest is calculated by determining the total number of shares sold short for a specific stock. This data is typically provided by exchanges and is updated periodically.

Investors can find short interest information through financial news outlets, stock screeners, or market reports.

The short interest ratio is available in ChartMill, it can be used as a screening filter. The following options are available:

Short Ratio (Short Interest Days to Cover):

• This ratio indicates how many days it would take for short sellers to cover their positions based on the stock’s average daily trading volume.
• A higher ratio suggests that covering short positions could take longer, potentially leading to higher volatility.

Short Float:

• Short float represents the percentage of a stock’s total available shares (the float) that are currently sold short.
• A high short float indicates significant bearish sentiment and raises the potential for a short squeeze.

Short Change%:

• Short change% measures the percentage change in short interest compared to the previous reporting period.
• This metric provides insights into how short-selling sentiment is evolving over time.

How to Use Short Interest in a Trading Strategy?

Traders can incorporate short interest into their strategies in several ways:

• Short Squeeze Opportunities: Look for stocks with high short interest and improving fundamentals or technical breakouts.
• Contrarian Approach: High short interest may indicate undervalued stocks, making them potential buy opportunities.
• Confirmation Tool: Use short interest to validate or challenge other technical or fundamental signals.

What Is a Short Squeeze?

A short squeeze occurs when a heavily shorted stock’s price rises sharply, forcing short sellers to cover their positions by buying back shares. This buying pressure can further propel the stock’s price upward, creating a feedback loop.

Short squeezes are often driven by positive news, earnings beats, or coordinated buying efforts.

The Mechanics of a Short Squeeze

Short squeezes begin when a stock's price rises contrary to the expectations of short sellers. When this happens, brokers may issue margin calls, requiring short sellers to deposit additional funds to cover their unrealized losses.

If short sellers are unable to meet these margin requirements, their simplest option is to close out their positions by buying back the shares they initially sold short.

This wave of buying can create a self-perpetuating cycle. As more short sellers are forced to close their positions, the increased demand for shares further drives up the stock price.

This compounding buying pressure can cause a parabolic surge in the stock's value, squeezing short sellers out of their positions. This phenomenon is why short squeezes are known for their sudden and dramatic price movements.

Tesla Example of a Short Squeeze Play

• Tesla shares rose more than 3200% during 2019/2020 with shorters losing a total of more than $38 billion.

• Short interest fell to barely 6% at the end of 2020 while it was over 20% a year earlier.
• Tesla’s meteoric rise in that specific period was driven by strong earnings, increased adoption of electric vehicles, and significant retail investor interest, creating a perfect storm for short sellers.

Short Interest Trade Ideas in ChartMill

The short interest screen in ChartMill incorporates solid criteria for identifying potential short squeeze opportunities or heavily shorted stocks. Here's a breakdown of the parameters and some suggestions for refinement.

Current Parameters:

• US Only: Limiting the screen to US stocks helps focus on a specific and active market.
• 50 SMA > 300K: Ensures adequate liquidity by filtering for stocks with a minimum average daily trading volume above 300,000 shares.
• Above $3: Refers to the stock price being greater than $3, which avoids extremely low-priced stocks (often riskier or less liquid).
• Below $100: Restricts the screen to stocks priced under $100, focusing on mid-range stocks rather than high-priced equities.
• Float < 20M: Targets stocks with a smaller share float, a key factor in identifying potential short squeeze candidates due to limited supply.
• Short Float % Above 10: High short interest is critical for identifying stocks with a greater likelihood of a short squeeze.

This is the direct link to the Basic Short Squeeze Trading Idea in ChartMill

Suggestions for Refinement:

• Add Days-to-Cover (DTC): Including a filter for days-to-cover (e.g., above 2 or 3) can provide insight into how long it would take short sellers to exit positions, increasing the likelihood of a squeeze.
• Combine Technical Indicators: Incorporate a technical breakout criterion, such as stocks trading near a 52-week high or showing bullish patterns like flag formations, to identify candidates already gaining upward momentum.
• Sector/Industry Filter: Adding a filter for specific industries with recent high short interest trends (e.g., tech or biotech) could enhance the relevance of the screen.
• Short Float % Gradient: Consider segmenting short float percentage (e.g., 5-10%, 10-20%, 20–30%) to explore varying levels of bearish sentiment and pressure.
• Relative Volume: Add a filter for (significant) volume increases relative to the average or the previous day, signaling heightened interest or news catalysts.

This is a direct link to the High Pressure Short Squeeze Trading Idea in ChartMill where the basic screen has been enhanced with two additional screening filters:

• Days to Cover
• Relative Volume

A current example from this ChartMill Short Squeeze Trading Idea

A nice up-to-date setup (on the day this article is published) based on the High Pressure Short Squeeze Screen mentioned above, is the stock CENTURI HOLDINGS INC (CTRI).

• The stock has a free float of only $16 million, a short float% of 16.94% and a days to cover ratio of more than 5 days.

• Moreover, the stock price is quoted in a narrow technical price range and the trend is also bullish.

• A further rise above the current high could give additional strength to the upward momentum as more shorters will want to close out their positions.

FAQ

How often is short interest data updated?

Short interest data is typically updated bi-weekly (every two weeks) in the United States. Exchanges like NASDAQ and NYSE report this data on a predetermined schedule, and the updates usually reflect the short positions as of a specific "settlement date."

However, there is often a delay of a few days between the settlement date and when the data becomes publicly available. In other markets, the frequency of updates may vary depending on the exchange and local regulations.

Are Short Interest and Put/Call Ratio the same?

While short interest measures bearish sentiment through stock shorting, the put/call ratio evaluates sentiment through options trading.

A high put/call ratio indicates bearish sentiment in the options market, while short interest focuses on actual stock positions. Both metrics provide complementary perspectives on market sentiment.

Conclusion

The Short Squeeze Trading Ideas in ChartMill are thoughtfully designed to help traders identify promising short interest opportunities. With the flexibility to add additional screening criteria, you can further refine these ideas to suit your specific strategies.

Short interest ratios provide valuable insights into market sentiment and potential volatility, offering both opportunities and challenges. By leveraging ChartMill’s advanced screens, traders can stay ahead of the curve, identify potential setups, and optimize their approach.

However, it's important to remember that while short interest can hint at opportunities, it doesn’t guarantee a short squeeze. Sudden market shifts or changes in broader sentiment can disrupt setups, making proper risk management a crucial part of any trading strategy.