Regarding short interest as posted by Bloomberg, has this been tested? That IWM short interest being the highest, is that an indication for buying since a squeeze is possible. How would this be tested?

Bill Rafter replies: 

We have done considerable testing of short interest data. I am on vacation and must speak anecdotally, but let me give our generalizations. The results suggested that half the time the shorts were dead right and the other half they were dead wrong. Very little middle ground. An exceptionally large SI value had no particular significance. That is, it gave no edge to the trader to pick subsequent direction.

Our research was attempting to approach the data differently from the way Phil Erlanger approaches it. Erlanger first identifies market direction, and then looks for possible short squeezes that will extend a rally to a more substantial level. Since we found no edge doing it our way, we have to conclude that until shown otherwise, Erlanger's approach was valid. We did find that it took a long time for short interest to be covered. That is, the rally durations were substantial as to both price and time. The shorts were slow to believe they were wrong. Sell-offs of stocks with high short interest tended to be less substantial as to both price and time.

One might simply conclude that drops occur fast and rallies take longer, and that the SI figures were of no significance at all. We disagree. That is, we think SI is certainly a contributing factor. It may not be a meal, but it certainly is seasoning.

We also watch and calculate some other sentiment indicators, including a price-based intra-day sentiment value. Looking at subsequent market performance with it is identical to what we learned from observing and testing SI: Sentiment indicators have an extending effect when they are wrong and a moderating effect when they are correct. 

David Wren-Hardin writes:

In this case, you have to think about what IWM is. Most of the time when people short a company, they do so because they think it isn't very good, that it should be priced lower. IWM, however, isn't a company. It's an ETF tied to the Russell 2000 index. So now you have to ask "Why would someone sell this?"

Some sellers, I'm sure, think the Russell should be lower, and happily sell IWM. But others might just be doing it as a hedge. If you wanted to hedge your Russell 2000 exposure with a basket of stocks, getting clean fills would be a nightmare, as would tracking the 1900+ individual names, most of which trade by appointment. You think it's hard to borrow IWM, try borrowing some of these tiny names. But with IWM, you can get the entire index in one shot. One can even spin a tale that if people are selling IWM against a net long exposure, that the IWM short interest is, in fact, a reflection of overall long sentiment.

The other thing to consider is that you can't look at short-interest in IWM purely in terms of percentage short vs. amount out there. An ETF is created when someone hands the trust the complete basket of stocks, getting the ETF in return. Now, IWM may be short equal to the float of all the stocks in the index, but more likely, given the basket example I used above, it's simply a pain in the rear to assemble complete baskets of stock and turn them into more ETFs. 





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