How to Analyze Short Selling Data

Why track short selling data?

Short selling data can offer invaluable market insights for active investors.. Short sellers are typically knowledgeable, high-conviction traders who conduct thorough research. If they are betting against a stock by taking a short position, it's usually because they have identified a major risk that has the potential to send the stock lower.

In this guide, we will look at how to analyze short selling data. By learning how to evaluate this data, active investors will be able to better manage portfolio risks, take advantage of investment opportunities on the downside, identify stocks with improving fundamentals, spot potential short squeeze candidates, and more.

Defining short interest

Short interest is the best place to start when analyzing short selling data. This is the number of shares that have been sold short divided by the total number of shares outstanding. As an example, if a stock has 100 million shares outstanding and 20 million of those shares have been sold short, the stock's short interest is 20%.

Short interest is often used as an indicator of market sentiment. A high level of short interest indicates that many institutions are betting against the stock because they predict a decline in value. This is generally a bearish signal.

Studies have shown that stocks with high levels of short interest typically underperform. ‘Which Shorts are Informed?' by Boehmer, Jones, and Zhang showed that stocks that were heavily shorted underperformed stocks that were lightly shorted by an average of 1.16% over the following 20 trading days (15.6% annualized).

What is considered “high” short interest?

A short interest ratio of 10% or higher is typically seen as high (i.e. a red flag). However, there are a few variables to consider:

Market – where the stock is traded can determine whether short interest in a share is high. In the US, equities with short interest of 10% or more are not uncommon. By contrast, in the UK, it's rare to see a stock with short interest of 10% or more.

Stock type – the market cap of a stock should be considered when evaluating short interest. In the US, it's common to see small-cap stocks with short interest of 10% or higher. However, it's not often you see a large-cap stock with this level of short interest.
Changes in short interest – A sudden significant increase in short interest is generally a bearish signal, as it tells you that short sellers are ramping up their bets on the stock. By contrast, a sudden significant decrease in short interest can be a sign that the outlook for the stock is improving.

Where can investors find short interest data?

One source for short interest data is regulators such as the Financial Industry Regulatory Authority (FINRA) and the UK’s Financial Conduct Authority (FCA). However, data from regulators is not always accurate.

In FINRA’s case, it only requires firms to report short interest positions twice a month. This means the data can be out of date. FINRA’s reporting also suffers from publication lag, as two days old data is published a week later, making it unusable for a systematic trading system. Meanwhile, the FCA’s data is based on short positions that are over 0.5% of the issuer’s share capital. So, it doesn’t include smaller short positions.

To gain the best picture of a stock's true short interest, it's a good idea to analyze data from several different sources. The short interest data on 2iQ’s terminal is gathered from different investment banks and passive investors that have lent out stock to short sellers with minimal reporting lag. This data, which includes loan rate statistics, utilization, number of tickets, granularity at the contract type level and more, can provide a more comprehensive view of a stock’s short interest.

What other indicators are there for short selling data?

Short interest is one of the most widely used indicators for examining short selling, but it isn’t the only indicator worth examining. Here are some other key metrics and indicators that investors should focus on when analyzing short selling data.

Utilization

An important indicator investors should pay attention to when examining short selling data for a stock is the utilization rate.

Utilization is the ratio of the number of shares that have been lent out to those that are still available on the securities lending market, given as a percentage. It's essentially a gauge of how much demand short sellers have for shares. A high utilization rate can be seen as a red flag. It indicates that demand for the stock from short sellers is elevated.

Utilization analysis should be done relative to short interest analysis. An extremely liquid large-cap stock, like Apple, might have very low utilization of less than 1% since there is so much supply compared to the demand for borrowing shares from short sellers.

By contrast, a small-cap stock like Vertex Energy, which is less liquid, could have a very utilization rate due to the fact that demand for stock from short sellers is high relative to the number of shares that are available.

Utilization should also be monitored over time. This allows for trends related to demand on the short side to be analyzed. If a stock’s utilization is rising rapidly, it is generally a bearish signal.

It’s worth noting that utilization can play a significant role in short squeeze events. A short squeeze occurs when a heavily-shorted stock rises in price, prompting short sellers to buy stock to close out their short positions. This pushes the stock's price up further.

When the utilization rate of a stock approaches or reaches saturation, it means that short sellers need to be more resourceful in finding shares to short. This can serve as a catalyst for an eventual short squeeze.

Canoo Inc is an example of a stock that experienced a short squeeze after having a high utilization rate. In July 2022, when utilization was 100%, the stock moved higher on the back of some good news. This forced short sellers to close their positions, pushing the share price up further.

Cost to Borrow

Another short selling metric is the cost to borrow shares. In order to short a stock, short sellers must borrow the stock and pay a loan fee to the lender.. The demand for the stock on the short side can be assessed by looking at these borrowing costs.

High borrowing rates, for example, are a sign that short sellers are heavily targeting the stock. Generally speaking, this is a bearish indicator.

The cost to borrow can differ across regions and market segments. In general, developed market stocks have lower borrowing costs. Additionally, borrowing rates for large-cap companies are often lower than for small-cap equities. So, once more, a relative analysis of this metric is necessary.

For example, in April 2022, tech-based consumer product company Aterian Inc had a cost to borrow of 180%. By contrast, Apple's cost to borrow at the same time was 0.25%.

Borrowing Activity Rating (BAR)

2iQ’s short selling data features an innovative ‘Borrowing Activity Rating’ (BAR). This rating, which ranges from one to 10, gives a clear indicator of the level of borrowing demand in a particular stock. A rating of one indicates a relatively low demand to short the stock, whereas a rating of 10 indicates relatively high demand. The formula to calculate the BAR includes inputs from outstanding loan fees, new loan fees, new loan volume, and utilization rates.

Days-to-Cover Ratio

Examining the loan days-to-cover ratio is important when looking at stock short selling data. This shows roughly how long it would take short sellers to cover their existing positions in days. It is calculated by dividing the total number of shares being shorted by the stock’s average daily trading volume. For instance, if a stock had short interest of one million shares and an average daily trading volume of 200,000 shares, its days-to-cover ratio would be five.

A high days-to-cover ratio indicates that it will take short sellers a long time to unwind their positions if the price of the stock suddenly rises. In other words, a major short squeeze might occur. A low days-to-cover ratio tells you that short sellers could easily and quickly cover their positions if the price of the security was to suddenly rise. A days-to-cover ratio of 10 or higher is generally considered high.

Short Selling Data: A Powerful Tool for Investors

In conclusion, short selling data can be valuable for investors, especially in terms of risk management. By looking at data on short interest, utilization rate, days to cover, and borrowing rates, investors can gain a clearer view of institutional sentiment towards a stock and potentially make more informed trading decisions.

As with any financial data set, short selling data should not be the sole determinant of an investment decision. A stock can sustain a high level of short interest for an extended length of time without experiencing a significant price decrease or short squeeze. Understanding how to utilize this data in conjunction with other more traditional forms of financial data is the key to success.

Want to delve deeper? Contact us today to find out more about 2iQ’s data and analytics offering, including our comprehensive short squeeze model.