Using Short Interest To Gauge Market Sentiment

| June 20, 2008 | 0 Comments

Well, it looks like the good days in the stock market are over.  At least in the short term.  It feels like the day after Christmas.  You can remember the good times but you know they won’t be back for another year.

This market is starting to make many investors nervous.  So don’t be surprised if you feel the same way.  Earlier this year I wrote about the falling market.  I encouraged people to hedge their portfolios.  Those who remained cautious through the last few months are laughing all the way to the bank.

Is it going to get worse?

Back in March the market seemed to bottom out.  Bear Stearns had collapsed and many thought the worst was over.  I know I certainly hoped it was.  Unfortunately, lots of investors seemed to change their mind.

Now I know what you’re thinking.  How do I know what other investors are thinking?

I’ll tell you, but first give me a minute.

Looking at the US economy we still have our fair share of problems.  The housing market is in shambles.  This hasn’t helped US consumers one bit. Consumer confidence numbers are at 20 year lows.

Toss on the troubled financial industry and we have a really big mess. Top that off with inflation in food and fuel.  And we’ll be cleaning this mess up for a long time.

I’m starting to question thoughts of a year-end rally.

I think we’ll have a few specific industries that’ll continue doing well.  Like agriculture, metals, mining, and technology.  The rest of the market’s looking pretty ugly.  Now I’m not alone in these thoughts.  So how do I know other investors agree with me?

Here’s the secret.  Short interest.

Each of the major markets report short interest on a regular basis.  Short interest is simply the number of shares that are borrowed and sold by investors.  The hope is that stock prices will fall and they can buy back the shares they borrowed at a lower price.  That’s what people mean when they talk about “shorting a stock.”

You’ve heard the old adage “Buy low and sell high?”  Well, short selling turns that upside down.  With short selling you want to sell high. . . THEN . . .buy low.

Recently the New York Stock Exchange (NYSE) released their short interest numbers.  It’s really fascinating data.  It covers not only individual stocks but the market as a whole as well.  The most recent announcement was astounding.

To the numbers . . . .

Short selling on the NYSE set a record for the first half of June!  As it now stands, investors have sold short more than 17.6 billion shares of stock.  If that sounds like a lot, believe me, it is.  What’s more amazing is the increase in the last two weeks.  Short interest increased 7.4% from May 30 to June 13.

Clearly a lot of investors think the market’s heading south.

Now I don’t normally short stocks.  In my mind it’s too risky.  If a trade moves against you, huge losses can pile up in the blink of an eye.  Besides, in order to short stocks you need to have approval in your trading account.  That means more paperwork and hassle.

But I do keep a close eye on short interest.

Knowing where the market stands with short interest can give a good glimpse of how investors are thinking.  Finding short interest is easy.  I go to the different market websites and do a quick search on short interest.  Not only do they give you a table of information but they also tell you another important number “Days to Cover.”

For example I went to the Nasdaq website.  I looked up the short interest on Microsoft (MSFT).  They showed short interest of 83 million shares and 1.4 days to cover.  “Days to cover” is just a mathematical calculation.  The number of shares sold short is divided by average trading volume.  It’s an easy way to track if short interest is going up or down.

I like to look at short interest to see if investors are bullish or bearish. It’s also great to see how short interest has changed over time.  If you see the number of days to cover increasing it’s a good sign that more and more investors think the stock is poised to fall.

Take a look at short interest.  I’m sure you’ll find it useful to gauge what the crowd is thinking.

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Category: Stocks

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The Dynamic Wealth Report works with a number of staff writers and guest experts who specialize in everything from penny stocks to ETFs to options trading. These guest analysts post under the 'staff writer' moniker for ease of use.

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