Friday, January 22, 2010

Longing for Shorts

We've discussed how looking at the amount of margin debt in the market can be used as a contrarian strategy: if margin debt is high, investors are optimistic, while if margin debt is low, pessimism is likely rampant, suggesting a buying opportunity may exist. But margin debt data is best applied to the market, whereas most investors are interested in individual stocks. Furthermore, margin debt data comes out a couple of months after the fact; since it can change very quickly, this data then becomes stale.

There is a useful contrarian indicator that takes care of those two problems, however (though it may introduce a few more as well). While value investors are known for perusing 52-week low lists in search of stocks that are out of favour, another way to measure the least popular stocks is by their short interest. If many investors have sold a company short, it shows 2 things. First, the market holds a lot of pessimism for this stock, and second, the shares sold short will have to be bought back at some point, indicating a potential bounce for the stock.

Fortunately, twice a month the NYSE publishes the stocks which have the highest number of shares sold short as a percentage of their total shares. Several sources put this data in an easy-to-read format, including the Wall Street Journal. For various exchanges, a current list of the top 50 stocks with the highest short interest as a percentage of their float can be found here:

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