Does anyone know if there is a Predictive Value to a stock's short interest ratio?

Bill Rafter writes:

Short Interest (SI) is a good area to research. We do a lot of work with it in our shop, and use it in our trading. However, the question you posted was specifically about the SI Ratio, something we consider unworthy of attention with a very few exceptions. If that ratio is all you are going to focus on, we suggest watching a good movie instead.

Many people simply look at the SI Ratio because it is available, say on Yahoo, Google or the Nasdaq websites. The problem is that ratio is more dependent upon changes in volume than changes in SI. Volume is also an area worth your attention, but not in that ratio. We maintain that there are better SI ratios to look at rather than that one. But to do that you are going to have to spend some time getting the data, which means not only SI and volume, but outstanding shares, insider ownership and institutional ownership. Then you will find the profitable relationships, but anticipate considerable work.

We have only found the volume contributor to the SI Ratio useful when in a price explosion the volume exceeds the number of shorts. That circumstance suggests that the price explosion (of a high-SI stock) is a result of short covering, which has now been exhausted. Obviously don't buy that stock!

Phil Erlanger is the regarded expert with SI data. His approach was to find stocks that one liked (say on the basis of momentum or whatever) and then look for SI patterns that would enable a greater run-up. We took the opposite approach, looking to first find good short interest patterns, and go from there. What we found was that Erlanger's approach is the better of the two if one is taking a cursory look at SI. That's because fully half of the stocks with high SI deserve it – they are headed south. Of the remaining percentage, about half of those mill around going nowhere. That leaves about a quarter of high-SI stocks overall that benefit positively, a few of which really take off.

Despite the above warnings, we would not purchase a stock without at least making ourselves aware of the SI.





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1 Comment so far

  1. Iven on June 6, 2014 8:47 am

    My organization has an analytical platform that looks at SI as a percentage of free float on loan, and strips out strategic shareholders who’s share holding should not be counted. Thus we can adjust for these factors and look at standard deviation moves. The platform is called OTAS and our firm is Olivetree Financial.


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