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Understanding Short Sales Terminology: A Guide for Investors

Updated: Feb 10



Short selling is a common practice in stock markets, allowing investors to benefit from price declines. However, to analyze and use this strategy effectively, one must understand the associated jargon. In this article, we'll delve into some key terms related to short selling and explain their significance.



Shares Short


  • Definition: The number of shares that have been sold short but have not yet been covered or closed out.

  • Explanation: Short selling is the practice of selling securities that an investor does not own, with the intention of repurchasing them later at a lower price. "Shares short" refers to the total number of shares that are currently being shorted in the market.

  • Example: If Investor A borrows and then sells 1000 shares of Company XYZ with the hope that the price will fall, those 1000 shares are counted as "shares short" until Investor A buys them back (covers).


Short Ratio


  • Definition: Also known as "days to cover." It's the ratio of shares short to the average daily trading volume.

  • Explanation: This metric gives an idea of how many days it would take short sellers to cover their positions, considering the average daily trading volume. A higher ratio might indicate that it could be harder for short sellers to buy back the shares without driving up the price.

  • Example: If there are 1 million shares of Company XYZ sold short and the average daily trading volume is 200,000 shares, the short ratio is 5 (1,000,000 ÷ 200,000). This means it would take 5 days of average trading to cover the short positions.


Short % of Float


  • Definition: This is the percentage of the available trading shares (float) that are currently being sold short.

  • Explanation: The float represents the number of shares available for trading. Not all outstanding shares are available for trading as some may be held by insiders or entities that hold them in a restricted manner. A high short % of float can suggest that there's significant pessimism regarding the stock, but it also may lead to a "short squeeze" if the stock price starts to rise.

  • Example: If Company XYZ has a float of 10 million shares and 2 million shares are sold short, the short % of float is 20% (2 million ÷ 10 million).


Short % of Shares Outstanding


  • Definition: This is the percentage of the company's total outstanding shares that are currently sold short.

  • Explanation: Outstanding shares include all the shares of a company, including those held by insiders and restricted shares. It provides a broader perspective than the short % of float.

  • Example: If Company XYZ has 15 million shares outstanding in total and 2 million shares are sold short, the short % of shares outstanding is 13.33% (2 million ÷ 15 million).


Shares Short (Previous Month)


  • Definition: The number of shares that were sold short as of the previous month's end.

  • Explanation: By comparing the current "shares short" with the "shares short" from the previous month, investors can gauge if short interest in the stock is increasing or decreasing.

  • Example: If Company XYZ had 1.5 million shares sold short at the end of July and 2 million shares sold short at the end of August, it indicates an increase in short interest over the month.


Covering


  • Definition: The act of buying back securities that have been sold short.

  • Explanation: When an investor covers their short position, they are essentially closing out their position by purchasing the same number of shares they initially sold short. This action can be motivated by a price decrease (securing profit) or a price increase (cutting losses).

  • Example: Investor A short sells 100 shares of Company XYZ at $50 per share. Later, when the price drops to $40, they buy back the 100 shares, making a $10 profit per share.



  • Definition: A sharp increase in the price of a stock due mainly to an excess of short selling of that stock.

  • Explanation: A short squeeze can occur when there is a significant upward movement in a stock price, forcing short sellers to cover their positions to avoid further losses. This rush to buy back the stock further drives the price up.

  • Example: If a significant number of investors are short on Company XYZ, and suddenly there's positive news driving its price up, these short sellers might rush to cover their positions, amplifying the upward movement.


Bear Raid


  • Definition: An attempt by investors to push the price of a stock down by heavy short-selling.

  • Explanation: A bear raid involves aggressively selling a stock short, hoping to drive its price down. This can sometimes be done for manipulative purposes, and such activities are monitored by regulatory authorities.

  • Example: If a group of investors colludes to short sell Company XYZ en masse, hoping to spread panic and push prices down, they're executing a bear raid.



  • Definition: The illegal practice of short selling shares that have not been affirmatively determined to exist.

  • Explanation: Normally, before short selling, an investor must borrow the shares or ensure they can be borrowed. Naked short selling bypasses this requirement, leading to potential market manipulation.

  • Example: If Investor A sells short 1,000 shares of Company XYZ without borrowing them or ensuring they can be borrowed, they are engaging in naked short selling.



  • Definition: A broker's demand for an investor to deposit more money or securities into their account so it meets the minimum margin requirement.

  • Explanation: Investors who short sell often do so on margin. If the position moves against them (i.e., the stock price rises), they might face a margin call, requiring them to either deposit more funds or cover their position.

  • Example: Investor A shorts 100 shares of Company XYZ, and the price rises significantly. Their broker might issue a margin call, asking them to deposit more funds or close out their position.


Buy-to-Cover


  • Definition: An order placed to close out a short position by purchasing the same amount of shares that were initially borrowed.

  • Explanation: When an investor has shorted a stock and wants to close their position, they place a buy-to-cover order. This ensures that the borrowed shares are returned to the lender. This might be done to either secure a profit (if the stock price has dropped) or to cut losses (if the stock price has risen).

  • Example: Investor A short sells 100 shares of Company XYZ at $60. When the stock price drops to $55, Investor A places a buy-to-cover order to repurchase the 100 shares, making a $5 profit per share.



  • Definition: An event where a trader fails to deliver shares they owe by the settlement date.

  • Explanation: After a short sale, there's an expectation that the seller will deliver the borrowed shares to the buyer by a specified settlement date. If they fail to do so, it's known as a fail-to-deliver event. This might occur in cases of naked short selling or other settlement issues.

  • Example: Investor A conducts a short sale of 100 shares of Company XYZ without ensuring the shares can be borrowed (naked short selling). When the time comes to deliver the shares to the buyer, Investor A cannot provide them, leading to a fail-to-deliver event.


Understanding short sales terminology is crucial for investors looking to gauge market sentiment around specific stocks. An increase in short interest might suggest bearish sentiment, but it can also increase the potential for a short squeeze, a rapid price increase caused by short sellers rushing to cover their positions. As always, while these metrics are valuable, they should be used in conjunction with other tools and analyses to make informed investment decisions.

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