Take a Peek at What Wall Street’s Short-Sellers are Doing

Although investors typically seek out stocks that are poised to rise, they also need to closely monitor what’s happening among short-sellers. These short-sellers often identify red flags well before Wall Street analysts or the financial media spot them. And if you are long a stock that is heavily shorted, you’ll need to dig deeper to try to find out why. (For example, you can go back to archived version of the most recent conference call to listen to what concerns arose during the Q&A).

Twice a month, the Nasdaq and the New York Stock Exchange issue updated information about stocks that are heavily shorted. You can find that data on their websites, shortsqueeze.com, or in the Market Data section of The Wall Street Journal.

Here’s a key breakdown of the short interest lists you need to know:

  • Biggest Short Positions — Stocks on this list are not necessarily there because they are in trouble. Instead, they may simply be seen as a negative bet on the broader stock market or a particular sector. In the most recent data, three of the most five heavily shorted investments are index plays such as the S&P 500 ETF (NYSE: SPY). But you should glance at the list to see if any companies stand out. For example, casino operator MGM Resorts (NYSE: MGM) is the eighth most heavily shorted stock on the NYSE, even though the company’s $4.5 billion market value puts its squarely in mid-cap status.
  • Largest Positive Changes —  In a similar vein, this list also tends to highlight big market and sector bets and is usually dominated by large caps. But watch for large changes. It’s worth examining why investors increased their short position in Mexican cement maker Cemex (NYSE: CX) by 30% at the end of August, even as its shares are closer to the 52-week low. Cemex is a proxy for construction in Mexico and the broader Mexican economy. So if you had any investments in Mexican stocks or funds, this spike in short interest could be flashing a warning sign.
  • Largest % Increases — This is useful in helping to look for fresh short ideas that may have slipped under the radar. For example, did you know that investors became doubly bearish on shares of Honda Motor (NYSE: HMC) in late August? The amount of shares held short grew by +111% in just two weeks. The move coincided with an ever-strengthening yen, which would crimp profits for all Japanese exporters. The bet against Honda can also be seen as a bet against Sony (NYSE: SNE), Toyota (NYSE: TM), Canon (NYSE: CAJ) and Hitachi (NYSE: HIT).
  • Shorts as a Percentage of the Float — To bet against a stock, short-sellers need to get their hands on shares that are being held in long positions in brokerage accounts (unless it’s a “naked short,” which is a topic for another day). As shares held by insiders such as management are not accessible, these short-sellers can only bet against freely-trading shares, or the floating shares. This measure helps you see how much of the freely-floating stock is being held by short-sellers. If the percentage is high, then short-sellers could be on to something.
    For example, short sellers have been betting that grocery chain Great Atlantic & Pacific (NYSE: GAP), which is known as “A&P,” might eventually go bankrupt. By the end of August, short-sellers held negative bets on more than two-thirds of the company’s float. The company had the last laugh here, announcing a likely sale of its Food Emporium chain in early September (after the latest short data was released), and reducing the chances of bankruptcy. Short-covering in recent sessions has pushed shares more than +20% this month.
  • Days to Cover —  This is the amount of shares held by short sellers, divided by the average daily trading volume. In case they’ve made a wrong bet, short-sellers like to know how a round of short-covering would impact the stock. If they’re wrong about Ritchie Bros. Auctioneers (NYSE: RBA), for example, shares might surge sharply higher, as it would take the equivalent of 59 days of trading volume for investors to make good on all of their bearish bets.

Action to Take –>
Short selling data is so important, even if you don’t short stocks yourself. You should be in the habit of reviewing the names in these categories at the beginning and middle of every month. You’d hate to find out that you were the last one to know that a key stock holding might be headed for trouble.