Enterprising Investor Forum

We’ve had a couple of emails from readers asking us about ’short selling’ and ’short interest’. Whilst, strictly speaking, this is not really one of our recommended strategies, here goes some info on the topic:

• Short Selling: this means that you sell a stock, commodity etc, that you do not own. In order to sell it, you have to borrow it from someone else with the obligation of giving it back - by buying it back on the open market. One would sell short is he/she thinks that the price will fall, thereby meaning that you would buy it back at a lower price than what you paid for it. Your profit would be the difference, basically the opposite of going long! Please remember that when you buy a stock, if it goes to zero you would lose 100% of your investment. However, if you short a stock, there is no limit to how high it can go before you manage to buy it back and you could end up losing more that your initial investment.

• Short Interest: the total number of shares that have been sold short. Usually, it is showed as a percentage. For example, 5% short interest means that 5% of the outstanding shares are held short.

• Days to Cover: based on the average daily volume of a share, it indicates how many days it would take all the shorts to buy back the shares they need to give back. For example, if a company has a daily volume of 5 million shares, and 10 millions share sold short, then it would take the shorts 2 days to cover.

• Short Squeeze: when prospects for a stock change for the positive and the price start to rise and investors who sold short need to close their short positions. This rush to buy back the shares, in order to cut losses, will force the share price higher very quickly.

This is the link to an good and more extensive video summary of the above:

http://youtube.com/watch?v=sj5EKg80yKQ

Enjoy!