Using Short Interest To Gauge Market Sentiment
The Dynamic Wealth Report
June 20, 2008
How The Crowd Thinks
by Brian T Mikes, Managing Editor
Well, it looks like the good days in the stock market are over. At least
in the short term. It feels like the day after Christmas. You can
remember the good times but you know they won’t be back for another
year.
This market is starting to make many investors nervous. So don’t be
surprised if you feel the same way. Earlier this year I wrote about the
falling market. I encouraged people to hedge their portfolios. Those who
remained cautious through the last few months are laughing all the way
to the bank.
Is it going to get worse?
Back in March the market seemed to bottom out. Bear Stearns had
collapsed and many thought the worst was over. I know I certainly hoped
it was. Unfortunately, lots of investors seemed to change their mind.
Now I know what you’re thinking. How do I know what other investors are
thinking?
I’ll tell you, but first give me a minute.
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Looking at the US economy we still have our fair share of
problems. The housing market is in shambles. This hasn’t helped US
consumers one bit. Consumer confidence numbers are at 20 year lows.
Toss on the troubled financial industry and we have a really big mess.
Top that off with inflation in food and fuel. And we’ll be cleaning this
mess up for a long time.
I’m starting to question thoughts of a year-end rally.
I think we’ll have a few specific industries that’ll continue doing
well. Like agriculture, metals, mining, and technology. The rest of the
market’s looking pretty ugly. Now I’m not alone in these thoughts. So
how do I know other investors agree with me?
Here’s the secret. Short interest.
Each of the major markets report short interest on a regular basis. Short interest is simply the number of shares that are borrowed and sold
by investors. The hope is that stock prices will fall and they can buy
back the shares they borrowed at a lower price. That’s what people mean
when they talk about “shorting a stock.”
You’ve heard the old adage “Buy low and sell high?” Well, short selling
turns that upside down. With short selling you want to sell high. . .
THEN . . .buy low.
Recently the New York Stock Exchange (NYSE) released their short
interest numbers. It’s really fascinating data. It covers not only
individual stocks but the market as a whole as well. The most recent
announcement was astounding.
To the numbers . . . .
Short selling on the NYSE set a record for the first half of June! As it
now stands, investors have sold short more than 17.6 billion shares of
stock. If that sounds like a lot, believe me, it is. What’s more amazing
is the increase in the last two weeks. Short interest increased 7.4%
from May 30 to June 13.
Clearly a lot of investors think the market’s heading south.
Now I don’t normally short stocks. In my mind it’s too risky.
If a trade
moves against you, huge losses can pile up in the blink of an eye. Besides, in
order to short stocks you need to have approval in your trading account. That means more paperwork and hassle.
But
I do keep a close eye on short interest.
Knowing where the market stands with short interest can give a good
glimpse of how investors are thinking. Finding short interest is easy. I
go to the different market websites and do a quick search on short
interest. Not only do they give you a table of information but they also
tell you another important number “Days to Cover.”
For example I went to the Nasdaq website. I looked up the short interest
on Microsoft (MSFT). They showed short interest of 83 million shares and
1.4 days to cover. “Days to cover” is just a mathematical calculation. The number of shares sold short is divided by average trading volume. It’s an easy way to track if short interest is going up or down.
I like to look at short interest to see if investors are bullish or
bearish. It’s also great to see how short interest has changed over
time. If you see the number of days to cover increasing it’s a good sign
that more and more investors think the stock is poised to fall.
Take a look at short interest. I’m sure you’ll find it useful to
gauge what the crowd is thinking.
• Beazer Homes (BZH) received an upgrade from UBS. You’ve got to
wonder what this analyst is thinking. I don’t see housing stocks getting
better any time soon.
• Cheesecake Factory (CAKE) was downgraded by Credit Suisse. The analyst
mentioned weaker demand and higher costs for the restaurant chain.
• Deutsche Bank initiated coverage on a number of biotech companies
including: Amgen (AMGN), Biogen (BIIB),
Genentech (DNA), Genzyme (GENZ),
and Gilead Sciences (GILD).
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