The quick answer is that if the percentage of a company's float that's shorted is more than 20%, that's high, indicating many investors think the price is going to decline. A company's float is the number of shares available for trading, and the ratio of shares shorted to the size of the float is called the short interest. This is calculated by dividing the number of shares shorted by the number available for trade. In this article, we'll review this calculation in more detail and discuss what it means when different percentages of a company's float are shortened.
Key Takeaways
- Float refers to the number of tradable shares of a company's stock.
- The percentage of shares shorted compared with the float is the short interest.
- Theoretically, the amount of a company's float that can be shorted is all of it.
- In reality, the short interest can surpass it in rare cases, but it's not typical for a stock to have a short interest more than 50%.
- When a company's short interest is high (above 20%),this typically means investors think that the shares are headed down in value and are looking to profit from the decline—or are using the short as a hedge in case it does.
Understanding Float and Short Interest
Short selling is an advanced trading strategy used by investors to speculate on an expected price decline of a stock or other security. The short interest is the number of a company's shares that have been sold short—but have not yet been closed out or covered. Usually, this number is expressed as a percentage, calculated by dividing the number of shorted shares by the number of shares available for trade, called the float.
For example, if 5 million shares are shorted and there are 20 million tradable shares, the short interest is 25%. In this example, the maximum number of shares that could be shorted would theoretically be 20 million shares. Since the float is simply the number of a company's publicly owned shares available for trading and tradable shares can be borrowed by short sellers, all of them could theoretically be shorted. In practice, however, there are rare cases when all shares—or even more shares than the float—have been shorted.
Real-World Example of a Heavily Shorted Stock
While it is uncommon for a stock to have a short interest of more than 50%, it does happen. This was the case for Peloton Interactive, Inc. (PTON)on Feb. 28, 2020, when around 26.99 million shares were shorted (compared with a float of about 42.03 million).
This gave the company a short interest of about 64%. When a company's short interest is high (above 20%),most of a company's investors are hoping the shares are heading down in price.
One danger from shorting stocks is the short squeeze, which occurs when the price of a heavily shorted stock moves quickly higher, thus "squeezing" short sellers and forcing them to close out their positions quickly, often at a loss.
What Does Short Interest Signify?
High short interest signifies negative market sentiment about the stock. Most often, investors are expecting a drop in the share price which will produce gains in their positions. Some investors may be shorting against the box to hedge a position they hold from losing value.
Brokerage firms that need shares for their clients might borrow stock from other firms, effectively going short and selling the borrowed shares to their clients. While it's not a good sign for a company when its stock has a high amount of short interest, it can be challenging to predict its future price because the reasoning behind shorts is not always clear.
Thus, short interest shouldn't be relied on as the only signal when trading. Underlying fundamentals and technical indicators should supplement signals from the short interest to see if there's a short or long opportunity.
How Short Interest Can Exceed 100%
Short interest can exceed 100% of a company's float because of how shares are borrowed and lent in the market. Let's say Adam owns 100 shares in a company—we'll keep it simple and say it's all the shares this company has. He has a margin account, which, in some instances, allows his broker to lend the securities in his account to a third party at any time without his knowledge.
Suppose Brian borrows your shares from your broker and sells them short, hoping to repurchase them later at a lower price. Celine buys the shares from Brian and can now also lend out these shares. Suppose, then, Daphne borrows the stocks and also sells them short. If this were to happen, 200 shares would have been sold short even though only 100 shares existed in the float. In this case, the short interest would be 200%. Though a rare occurrence, it is possible that in extreme instances, the number of shares shorted can exceed 100%.
These rare situations usually occur with small-cap stocks with a small float and high short interest. However, just because it's rare doesn't mean you shouldn't watch for it: a short interest of more than 100% is a prime time for the short squeeze, where the stock price can skyrocket due to short sellers rushing to cover their positions.
What Is a High Short Interest Ratio?
There are no hard and fast rules for this. However, ashort interestas apercentage of floatabove 20% is generally consideredhigh, which could indicate significant negative sentiment.
What Are Low-Float Stocks?
Low-float stocks have a relatively low number of shares available for public trading. There isn't a specific number of shares that indicates low float since it depends on the size of the company, the float percentage, and the float of similar businesses. Companies with a meager float percentage (fewer than 10 or 20 million floating shares) are often called low-float stocks.
How Does Short Interest Affect Stocks?
When investors short a stock, they indicate that they believe its price will fall. That can negatively pressure a stock's price as its price follows investor sentiment. In some cases, a short squeeze can occur if a heavily shorted stock rises in price. When this happens, many short sellers who want to close their positions buy shares in the shorted company. This flurry of buying pushes the price even higher. causing more short sellers to rush to close their positions.
The Bottom Line
Short interest in a stock can reach a high percentage of the stock's overall float. While, in theory, short interest should not exceed 100% of the float, it can sometimes go even higher. A high percentage of short interest can indicate negative sentiment for a company and lower the stock price. Investors who want to learn about the market sentiment towards a company may use the level of short interest as one measure of investors' feelings about the company.
