Tag: short selling

  • Metrics For Short Selling Stocks

    Metrics For Short Selling Stocks

    Metrics For Short Selling Stocks
    Different traders can adopt different metrics for short selling stocks but these few can point out the current market positioning and traders’ sentiment.

    Metrics for short selling stocks are used to uncover the potential short-sell candidates and to track the activity on stocks. There isn’t a formal method but, in short, different traders use different metrics for different purposes. The common thing for all of them is to recognize the best candidates for short-selling and to track them.

    Of course, each trader is unique in style, appearance, or goal and the same comes when deciding what metrics for short selling stocks they use.

    Some traders would add many variables to take into account everything that possible can influence a company’s earnings. For example, they will examine all factors that might cause the earning to go lower which would show a great opportunity for short-selling the company’s stock.

    However, other traders will look at a few important metrics for short selling stocks in several main variables but they will examine them in-depth.

    But both types of traders would like to gather as much as possible data, so it isn’t unusual that there is no clear separation on categories. So, metrics for short selling a stock can be divided into several different methods of measuring. We will present to you several metrics that we found to be important.

    SIR as one of the metrics for short selling a stock

    Short interest ratio or SIR, basically tells traders the number of shares available for short selling. If this SIR ratio is high that means that there is higher attention on that stock because short-sellers are expecting the stock price to fall very soon. That also means that traders believe that the stock is currently overvalued and they assume the stock will fall in price.

    For traders, this is a bearish indicator, meaning the market is pessimistic on that stock since it has a high short interest ratio. Should traders get into stock with a high short interest ratio? That depends. If high SIR is caused due to mispricing there are a lot of chances to go short with it. But SIR can be high due to the fact that the stock is simply bad. The ability to make a distinction why the SIR is high makes the difference between winning and losing trades. 

    As you know, short-sellers have to buy back their position if they want to profit and that might cause increasing interest and the stock could increase in price. This uptrend may occur very fast if too many short-sellers would like to cover fast in a short time frame. This situation is described as a short-squeeze. The consequence is that traders will not profit from this trade.

    Nevertheless, the SIR is one of the metrics for short selling stocks and can be calculated to get a quick tip if the stock is massively shorted or not, compared to its daily trading volume.

    SIR is easy to calculate, the total shares held short should be divided by the average daily trading volume of the particular stock. 

    SIR = Short Interest / Average Daily Trading Volume

    The short interest ratio

    You can find more than one definition for the short interest and several ways to calculate this ratio. The short interest ratio could mean the same as the days to cover or the short interest as a percentage of float.

    But the principle is the same: a stock with a high short interest ratio has a high number of shares sold short or, in other words, a low number possible to trade. 

    The short-interest ratio is simple to calculate. Take the number of currently short sold shares and divide that number by the average daily trading volume for the particular company. For example, if traders have shorted 6 million shares of that company and its average daily volume is 2 million shares then the days to cover is 3 days. Hence, if all of the short-sellers want to close their positions at the same time, it would take around three days for them to do so.

    The ‘days to cover’ expresses the total amount of time for all short sellers participating in the market with particular stock to buy back the shares that the broker borrowed them.

    Short Interest To Volume Ratio = Current Short Interest / Average Daily Share Volume

    “Days to cover” is a useful ratio for traders. 

    High value to this ratio is a bearish indicator. It might be a signal that everything is not great with company performance.

    It can be a sign of how bearish or bullish traders are about some company. Also, traders could get the idea of potential future buying pressure thanks to this ratio. The short-sellers don’t have too much time to buy back stocks and to get out of the position. Hence, this is one of the possibly most important metrics for short selling a stock. Naturally, they want to buy the shares back at the lowest price possible. Hence this need to get out of their positions could force prices to move higher. The longer the buybacks take, the longer the price rally will continue. A high “days to cover” ratio can be a signal of a short squeeze.

    Short interest ratio expressed in percentages of float

    The other way to calculate the short-interest ratio is by dividing the number of shares sold short by the total number of shares available for shorting. But expressed in percentages.

    For example, the company has 20.000 shares but 5000 shares are locked-in and cannot be sold because the company gave them to the management. So, the company has a so-called public float of 15.000. Let’s say that another 5.000 are sold short. So we have to calculate the short-interest ratio.

    (5.000/15.000) x 100 = 0,33 x 100 =  33

    This gives us a short interest ratio of approximately 0,33 or 33%.

    Short interest of float above 50% means that short-sellers wouldn’t have an easy covering of their positions if the price turns to rise.

    How to trade by using metrics for short selling stocks?

    The same as we use metrics to evaluate the stock, these metrics can be interpreted in several ways.

    For example, when we have many short-sellers on one stock, it may be because the company isn’t successful. There are numerous reasons why the company isn’t profitable. Sometimes it can be due to the market shifts and the company’s business model that became unprofitable. Also, maybe the officers of the company are connected to some gossip about possible nefarious actions.

    Or the other example, a high short interest ratio could be a signal that the stock is a bargain. When some company is developing a new product, reports in its early stage might indicate the product could be risky. What is possible to happen? Short-sellers will open their positions driving the short interest above, for example, 20%. But later, when the product appears as very useful and popular, short-sellers are forced to cover their positions because short interest is high. This could cause the stock price to rise, and there will be a strong rally. 

    This potential for unexpected rallies in stock with a high short interest ratio, causes many experienced traders to see this metric as a bullish indicator.

    Bottom line

    Different metrics can be used to classify short-sell candidates. But these metrics are worthless if you never compare SIR and current short interest with previous levels and recognize possible overexpanded levels of stock. Compare the current metrics for the same company’s performances over time. Metrics for short selling stocks are worthless if you don’t do that. Your plan to become a short-seller will probably fail, and you would end up empty-handed.

  • Short Selling For Profit

    Short Selling For Profit

    Short Selling For The Profit
    What to do with stocks when the price starts to decline? Bet that a stock will fall more.

    By Guy Avtalyon

    Short selling for profit is a trading strategy that attempts to profit from an expected decrease in the price of a security. Basically, a short-seller wants to sell at a higher price and buy at lower.

    How does short selling for profit work? 

    Let’s you are a trader and you have some information that some stock will decrease in value by the expiration date. Ofc, you don’t hold that stock but you can borrow it from a broker. For example, you borrow 100 stocks at $10 market price. And you open the position, meaning you want to sell them at market price by their expiration date. And you succeed. Then you close your short position and sell your borrowed stocks for $1,000. But before you give back that 100 stocks to your broker you are betting that their price will decrease in value before the expiration day. That happens. Now, you are buying these stocks at a lower price, it is called covering the short position. 

    Let’s say, the price of your borrowed stocks declines at $6 each. 

    You sold them at $1,000, bought them at $600. Return 100 stocks to the broker and you pocket $400.

    (100x$10) – (100x$6) = $400

    The risk in this kind of trading is literally unlimited because the price may rise and rise to infinity. 

    But, the profit can be huge, also. The previous example showed a short-selling for profit. Well, by using short selling you may gain loss too.

    Example of making loss while using short selling.

    The vice versa case is when stock price increase in value during the time while you are holding them.

    Let’s say their market price rose at $14 each and you are holding 1oo stocks. The equitation will be

    $1,000 – $1,400 = – $400

    You borrowed those stocks at a $10 market price. But despite your expectations, the price increased which means you made a wrong bet. But you have an obligation to return those to the broker, hence you have to buy them back at that higher price. In this transaction, your loss is $400.

    Short selling for profit is a method for traders to benefit from a drop in a stock’s price.

    Short selling is only possible by borrowing stocks. The problem is they are not always available because when they are you may be faced with a crowd of other traders that already massively trade them. 

    Is short selling for profit risky?

    The short-selling for profit can be risky and questionable. When a huge number of traders choose to short some stocks, their actions will make a great influence on the stock price. With such big traders’ interest, the price will decline sharply. That is not a good situation for companies. Their market value decreases. Sometimes the markets forbid short-selling, especially during the economic crisis.

    As I said, short selling is risky for plenty of reasons. You can make a great loss if the stock price increases instead to decrease.

    The other reason is that the sharp increase in selected stock may cause traders to cover the position all at once. Moreover, short-covering usually force the price to go up. Then you have a situation that more and more short-sellers are covering their positions and such stock is grasped in a so-called short squeeze. So, like a chain of unfortunate events, right?

    The main purpose of short selling for profit is when you borrow the stocks from the broker to sell them instantly and buy them back at a lower price. And return them to the broker. When the whole process is finished you should profit from the difference in stock price.

    Risks of short selling

    Short selling involves a magnified risk. When you buy a stock you can lose only the money that you have invested. For example, if you bought one share at $300, the maximum you could lose is $300. Stocks can fall to $0 and that is the maximum, there is no stock that may fall below zero. The maximum in your potential loss will stop at your initial capital invested.
    In short selling, you can potentially lose an infinite amount of money. Stock can increase its value for an infinite time to an inconstant price. So, you’ll have an infinite loss.
    For example, let’s say you enter a short-selling at $200, and suddenly the stock price increases by 300% to $800. You’re obliged to buy the stock back and return them at $800, essentially losing 400% of your capital. actually, you are in incredible debt.

    Just be careful when you bet against stock price.