Using short interest in your stock trading
Beginner Stock Market Investing, Stock Market Investing Advice, Stock Market Investing Strategies
Because stock prices are constantly rising and falling, you must have realised that money can be made both by buying stock in the expectation of a price increase and selling stock in the expectation of a price decline. Just as there are investors are looking for undervalued stock to be purchased at a profit, there are investors looking for overvalued or weak stock to be sold at a profit. In essence, short selling stock is the opposite of buying and the seller is selling stock that he does not own in the expectation of a decline in prices. If you feel that a particular stock is going to lose value, you can borrow the stock from your broker-dealer and sell it in the market. When the price declines, you can cover your position, buy back the stock and return it to your broker-dealer. The difference represents your profit.
The major problem with selling short is that you take a loss if the price goes up when you have to buy back stock to return to your broker-dealer. Your broker-dealer may also ask for the return of his stock and the closure of the position regardless of whether you are in profit or loss. This situation will normally arise only if the broker-dealer has any doubts about your creditworthiness. The number of shares sold short by investors at any point in time that have not been covered is called a short interest and can be expressed as a number or a percentage. For example, if a company has 10 million shares outstanding and the number of shares sold short at the particular point in time is 1 million shares, the short position is 10%. As we shall see, this can be a useful indicator to use in your stock trading.
Many exchanges track the short interest in all securities and many of them even provide the online short interest position for a given security. You can use this information to assess the market sentiment about a particular stock and whether the overall sentiment is bearish or bullish. In particular, a large increase or decrease in short interest to provide a telling indicator of how market sentiment is heading. For instance, you may notice a large increase of say 10% over a period of one month in a particular stock. This increase in the number of people who believe that the share price will fall should at least have you rechecking your research and the latest news on the stock to see if there is any basis for this belief.
These kinds of stocks should be treated with caution because short sellers have been known to be wrong. In fact, if there is a high degree of short selling interest, contrarian investors who bet against market sentiment may well conclude that because of the degree of short selling, the stock price is already at a low and can only go up. However, despite its ready availability, many investors tend to overlook short interest altogether. While you should not rely on this short interest alone, it only takes a few seconds to obtain the information to validate your other research that the particular stock price is headed downwards.
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