2024.04.11
2022.11.17 Days to Cover: What Does Short Interest Ratio Mean?
Jana Kanehttps://www.litefinance.org/blog/authors/jana-kane/
In the financial market, there is a lagging indicator that helps traders to define the average number of days needed for a stock to be covered and closed. This index is called days to cover and is an efficient formula that describes the level of the bearish and bullish trends of an asset. In this article, we will provide complete days to cover explanation, the ways traders use it, how to calculate it as well as its affiliation with the short-interest ratio.
The article covers the following subjects:
- What Is Days to Cover and High Short Interest Ratio?
- Days to Cover Ratio Formula
- Days to Cover Ratio Calculator
- Examples
- How to Trade Using Days to Cover
- Conclusion
- Days to Cover indicator FAQ
What Is Days to Cover and High Short Interest Ratio?
The short interest ratio is an efficient way for traders to spot if shares are heavily shorted or not against their average daily trading volume. Accordingly, days to cover is an index that defines the average amount of days that are necessary to let short sellers cover their positions. Thus, days to cover and the short interest are treated as the same because they display the short interest data of a share.
No matter which definition traders use, the core principle is based on an asset’s interest ratio. If a share is either oversold or has a very low amount to provide for trading, it is said that the stock has a high interest ratio. As a result, many investors will rush to buy, and this will push short sellers to follow and cover their positions.
What Is the NYSE Short Interest Ratio
New York Stock Exchange short interest is a type of short interest data that refers not only to one company’s stock but to the total amount of U.S. shares. Thus, the way it’s calculated is different from the other versions of short interest. The formula is based on the past 30-day period and is calculated by the total number of shares on the US stock market divided by the daily volume of NYSE for the last month. Depending on the level of NYSE short interest, it can indicate a bearish or bullish attitude of traders regarding the entire exchange.
As an example, consider that there are 15 billion shares sold in the U.S. stock market in June, and the daily volume for the same time is 3 billion shares per day. Thus, the NYSE short interest will be represented by the following equation:
- 15 billion/3 billion = 5
The result shows that traders who have short positions need approximately five days to cover them.
Where to find Short Interest Data
Traders can get informed about the details of a stock’s short interest data through various reliable websites. These online sources frequently update information reports, charts, and short interest tables that provide information about particular equity or the stock market as a whole. Some examples of those sites are the New York Stock Exchange (NYSE) and Nasdaq.
Days to Cover Ratio Formula
Days to cover is an indicator that defines the average time that traders need to cover their short positions so they don’t face high losses. The formula is based on data points from the past performance of a share and is calculated with the following simple equation:
In simple words, to calculate the days to cover, traders need to take the current shorted shares of the stock that they're interested in and divide them by the average daily volume.
Days to Cover Ratio Calculator
The days to cover formula is based on the calculation of the number of the recently shorted shares divided by the average daily volume of shares shorted in the same stock. This result is based on the data points of the previous month. The most simple calculator that traders use to find the days to cover ratio is:
For example, if the current short interest of a stock is 5 million shares and its average daily trading volume is 15 million shares, the result will be: 5,000,000/15,000,000 = 0.33 days. Conversely, if the same stock has an average daily trading volume of 1,000,000 shares per day, then the result may change dramatically: 5,000,000/1,000,000 = 5 days.
Examples
The short interest of a stock and the days to cover are both sentiment indicator that presents the entire short position of a stock. Below are two examples with positive overall market sentiment and a pessimistic sentiment.
High Short Interest Examples
A popular example of high short interest is illustrated with GME shares. The stock of the company in the previous year was valued at around $18. Most fund managers borrowed stock with a much lower price expecting that it would fall more. However, a massive move of investors in February 2021 led the share price to experience an upward momentum and reach $500. As a result, the firms that invested in short trades lost billions from that event.
Low Short Interest Examples
The days to cover calculation gives investors a result that indicates an asset’s bearish or bullish movement. If traders expect that the share price will continue to rise or it will remain stable, that's a sign of low short interest. In the chart below, there is no pessimistic sentiment from investors towards the stock price in the period after the middle of March. The stock’s value is rising as expected.
How to Trade Using Days to Cover
The days to cover indicator is a very useful tool for traders in various ways. It can be a variable of a trader's bearish and bullish level about a share. This can help to form future investment plans and strategies. Through the level of this index, traders can be alerted that the company may not be very profitable due to open market shifts and low performance.
Moreover, investors can monitor the course of the short interest indicator and spot potential upcoming raises in a share’s buying pressure. In simple words, if more stocks of a share are being sold, investors with short positions will be pushed to buy at the lowest possible price to cover and close their trades. This will lead to a sharp uptick in the stock’s value that can continue as long as the days to cover period lasts.
Additionally, a high days to cover can indicate future profitable investments. This can happen, for example, if a company has a new product that is considered unsafe from the initial reports. As a result, the share price is low and many short sellers are pulled in to buy. This can lead to a push of the short interest percentage and a rise in the stock price. Investors spot this as a sign of short squeezes and look to profit from the upcoming fruition of the share.
Conclusion
Days to cover is an efficient lagging indicator that helps investors to understand if a stock is likely to experience short squeezes. It displays the average amount of days that short sellers need to cover their positions. This index can be a bearish or a bullish indicator for investors. Some may decide to go short and others to aim for a future profit by going long. In any case, as the days to cover become higher, short sellers will try to avoid losses and start buying at the lowest possible price. This will lead to a significant rise in the stock price.
Days to Cover indicator FAQ
The result of a days to cover calculation can vary from very low values such as 0.2 to high values such as 8. A promising and profitable indication can be considered a rather high interest ratio. Thus, investors are focused on a high short ratio that is between 8 and 10 days or higher.
There is not a specific period that traders have to cover a short position. It depends on when the lender may request the number of shares to be returned by the investors. Of course, as long as the short sellers keep their position, they have to pay their amount of interest. Only when they can’t afford to repay, lenders can request back the shares.
Investors consider a high short ratio as a bearish sign. Thus, they try to take advantage of that high rate and invest for a higher profit. For traders, a short ratio between 8 and 10 days or even higher is considered an opportunity. On an occasion like this, the gap becomes difficult to be covered and the short sellers will be forced to buy and raise the price of the stock higher.
The signs that indicate that a stock is being shorted are when it is being sold rapidly or when a great number of stocks are being sold short. Short sellers try to cover their positions by investing in more shares of the stock. As a result, the price reaches very high values.
Days to cover is a lagging indicator that is used to define how many days are needed so the short sellers will cover their positions. Moreover, it determines the possibility of a share being short squeezed. This makes short sellers struggle to exchange their shares. This is used by investors to increase the demand for the stock as well as its price.
The definition to cover short is used in the financial market when a short seller is trying to cover his position. Thus, when a trader is trying to cover short, he is buying back securities that originally were sold short and returns the borrowed stocks he needed to start short selling.
The short interest ratio is considered a bearish sign that pushes the price of the stock lower. The shares are sold at a very fast rate, which leads to a potential short squeeze, pushing the price of the stock even higher. Thus, investors aim at a ratio between 8 to 10 and higher, considering this size is leading to an upswing.
The days to cover indicator measures the average number of days it would theoretically take for all short sellers to buy back their shares. To calculate this, you divide the average daily volume by the number of shares held short. This cover metric is useful for traders because it can give you an idea of how difficult it might be to buy or sell a stock.
A short squeeze is when short sellers are forced to buy back their shares at higher prices due to increased demand, resulting in a sharp increase in the stock price. A high days to cover indicates that there are more short sellers than average, which means there is potential for short squeezes if demand increases. Conversely, a low days to cover metric means there are fewer potential sellers, so it would take less buying pressure to trigger a short squeeze.
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.
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