The value of short-interest

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John Forman - The Essentials of Trading author

Short interest is an interesting statistic that’s worth understanding. It tells you how many shares of a stock or ETF trader are short in the security. This is something very worth tracking because it can tell you very useful things about a stock’s recent trading, and more importantly, what forces could be driving it going forward.

An example of this is the Homebuilder’s EFT (XHB) which tracks the group of stocks including the likes of Hovnanian, Beazer Homes, and others. The group has been under a lot of downside pressure in recent weeks as the result of higher interest rates. Not surprisingly, short interest in XHB has been rising as folks have been shorting the ETF in the view that higher interest rates would hurt the group.

Here’s the thing about shorting a stock or ETF, though. At some point you have to buy it back to cover the short position. Furthermore, short sellers are generally not long-term players in the markets because it usually costs money to carry a short (margin interest and potential dividend payments), so short sellers tend not to hold positions for long periods of time. If prices start going against them, they tend to bail out quickly, creating even more buying and accelerating price gains. It’s kind of fun to watch, actually.

Getting back to XHB, despite all the short-sellers piling in to the ETF, it hasn’t been able to push through the April lows. That should concern the shorts, because it sets up a potential situation where the bottom has been put in and long-term buying will take over. If that happens, and prices start moving higher, the shorts are going to have to bail on their positions.

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