Good Short Interest Ratio That I Loved And Why

Do you think that short Interest lower than 10% indicate sentiment is good and prices will go up?

That's the worse assumption you can and I will share the high short interest ratio I loved and why.

Firstly, what makes a good short interest ratio? Using reverse psychology, a short float or short interest ratio over 10% is a good way to screen stocks that can break out, if the stock fundamentals and outlook are strong. A short squeeze will eventually happen when the company exceeds expectations.

Why High Short Interest Ratio Is Good

It is difficult to gauge short interest and float but still what is a high short ratio? High short interest is any stocks with a high percentage of shorts compared to its float, usually above 10%.

There are many reasons why a high short-interest ratio is good:

  • While most shorts are valid, a surprise in the fundamentals and outlook of a company will reverse the negative trends
  • A spike in price leads to a short squeeze that further spike up the stock price when people have to buy stocks to cover their position

I usually use FinViz to find stocks with a short ratio above 10% but usually ignored all except a few stocks. Example included 

  • Carvana, a used car company with great management. I sold it though as I have no oversight from overseas since it is a US-only business. One idea is asked if I could bring them into my country but probably unlikely it is a tough business to undercut middleman (I know the de facto classified ads company in my country trying hard, besides property but not sure if it is working).
  • SEA Group, I didn't know it was listed in the US until I used the screener. Its business Shopee is a company I understood as a seller/buyer so I bought into it quickly and still kept it till today. 

Therefore, it is important to buy only if you have knowledge that negates the probability of a complete stock price crash.

Why Do People Short?

The reasons why stocks are shorted heavily are due to: 

  1. having a declining business; or
  2. poor or shady management issues; or 
  3. having a huge price surge (leading to people betting against the parabolic move).

The reasons I loved the high short ratio is only for those companies due to (3) price surge, and still have strong business and management.

This was found to be more significant when there is accrual manipulation (one of the bad use of accrual accounting over cash accounting), bad news hoarding, CFO's equity incentives, weak governance monitoring mechanisms, excessive risk-taking behavior, and high information asymmetry between managers and shareholders.

For example, I just did not like to buy any of the below top shorted companies as of 2 Dec 2020 from financhill.com:-

  • GameStop Corp - The CEO, George Sherman, and the board took a 50% cut due to a 23% revenue decline and store closures from the pandemic.
  • Ligand Pharmaceuticals Inc
  • Bed Bath & Beyond Inc - I think Bed Bath & Beyond is beyond me on how they survived times and again. Even if they keep surviving years after years, I just don't see a turnaround in them taking market share.
  • Mallinckrodt PLC
  • Macerich Co
  • Briggs & Stratton Corp
  • AMC Networks Inc
  • Clovis Oncology Inc
  • Tanger Factory Outlet Centers Inc
  • Corbus Pharmaceuticals Holdings Inc
  • Brookfield Property REIT Inc
  • Chesapeake Energy Corp 
  • Pyxus International Inc
  • Macy's Inc
  • Frontier Communications Corp
  • Children's Place Inc
  • iRobot Corp
  • Inovio Pharmaceuticals Inc

Why Don't I Short If It is Mostly Right

It is costly to short stocks and you must time it to work usually.

Costly to Borrow Stocks For Shorting

You have to borrow stocks which is not easy based on hearing many day traders. The alternative is using puts but it is difficult and costly too.

Even if you are a professional trader or fund, shorting is very difficult to profit from.

If you don't believe me, look up Mutiny Fund.

Mutiny Fund which tried to long volatility affordable realized that prices didn't adjust as expected too ending up with less profit than expected even with the high volatility that should favor it.

Timing Is Key To Shorting

You are betting against the market all the time and it cost you money. You can bet less or bet at the tail end (imagine black swan event). However, the risk-rewards usually is already adjusted and do not work unless you are lucky in your timing. A black swan event is as per its name, nobody knows when. 

That's said a few stocks shorted successfully like Universa Funds which seem to hit over 4,000% profit from the March 2020 event. Do read them up about the goal of investing with the Kelly criterion.

Author
Sky Hoon. Read Full Bio
Website Owner, Twitter-er
He has been trading since 2008. He started this blog to share the journey about option trading. He dabbled in stocks, bitcoin, ethereum (in Celsius Network), ETF (lazy Dollar Cost Averaging) and also built websites for fun. He used this as a platform to share my experiences and mistakes in trading, especially options which I just picked up.

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