Time Frame: Long
Category: Contrary Opinion

Description

The short interest ratio is one of the oldest contrary indicators. In its simplest interpretation it represents how many days of average volume it would take for all short positions to be repurchased. As an indicator it combines two market driving forces - sentiment and the demand for stock. The level of short interest is a reflection of the bearish sentiment among short sellers. The indicator's predictive value is based on the belief that when there is a predominant opinion among short sellers it is usually wrong. Its effectiveness is enhanced by the need for short positions to ultimately be covered (repurchased). Therefore, increasing short interest levels will lead to a higher demand for stock. The logic follows that a high short interest ratio will support higher prices because in a declining market short sellers become buyers locking in profits. In addition, in a rising market short sellers are forced to cover their short positions, propelling the market even higher in their attempt to limit losses.

Calculation & Significant Levels

NYSE Short Interest Deviation: A monthly calculation of the percentage deviation of the current short interest ratio from its 12-month average. The current short interest ratio is the sum of all shares held short on the NYSE divided by the NYSE average daily volume over the past 30 days. As markets have become more sophisticated with the proliferation of hedged trading strategies the short interest ratio has developed an upward bias. The effects of this bias are compensated for by calculating the indicator as the level of short interest relative to its average over the past year. A bullish reading is >10% and a bearish reading is <-10%.

Formula:
(Current Short Interest Ratio - 12 month average Short Interest Ratio)
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             (12 month average Short Interest Ratio)

Gauge Elements: Magnitude, Time
Updated: Weekly (as of Friday close)

Strategy