How to Benefit from Short Sellers

There have been several occasions in which it was reported that short sellers have managed to push the major indexes up. While this information may mean a little to some investors, others may find it useful when evaluating stocks.

Short interest increase can be interpreted in many ways.

Short sellers make profits when the prices of stocks fall. In the case of overpriced stock, most investors expect its price to fall in the near future. As a result they will short the stock. This will eventually lead to profits for them when the price of the stock decreases. On the other hand, if they fail in their predictions, in order to protect their positions they will have to repurchase the stock at a higher price. This may lead to a further increase in the price of the stock if this action is taken by a greater number of short sellers.

Most short sellers apply selling short in order to hedge their positions. However, they don't represent concern to other investors since they are often wrong in practical terms.

However, as an investor you may use some of the forecasts of short sellers in your advantage.

For instance, you can apply short-interest ratio to see whether short sellers expect that a particular stock, which is part of your portfolio is about to fall.

Short-Interest Ratio = short interest / average daily volume of the stock

If the result of the calculations is a number greater than 2, then you can expect a rise in the price of the stock in the near future. This will most probably be caused by the actions of short sellers undertaken to cover their positions.

On the other hand, if the value of the short-interest ratio is low, short sellers forecast a decrease in the price of the stock or no change at all.

If you cannot make the computations of the short-interest ratio on your own, you can refer to one of the online sources, such as Smartmoney.com.

Final Piece of Advice

Use short-interest ratio and the number of short sellers to evaluate the stocks and their future price movements. However, you should keep in mind that you should not overlook other methods for stock valuation.

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For knowledge we can highly recommend you subscribe to the The Wall Street Journal.

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