There are a lot of statistics to be mindful of when you’re looking to enter into a short position. Among these is the “days to cover,” or short ratio. This ratio provides a look at the number of expected days that are required to close out all short positions; as a result, it gives an indication of future buying pressure, making it something to consider the next time you want to open a short position (or are looking to make money on a stock caught in a short squeeze).
Days to cover explained
Days to cover — also called the short-interest ratio or short ratio — is calculated by dividing the current short interest by the average daily trading volume. For example, say ABC stocks has 5 million shares short and an average daily trading volume of 2 million; its days to cover (5M/2M) would be 2.5.
Because the short-interest ratio measures expected future buying pressure on a stock, it helps you figure out if there will be a short squeeze in the future. When a stock rises significantly, short sellers start closing out positions by purchasing shares on the open market; stocks with a high short-interest ratio are on the radar for market participants, as it could be an indication that the stock could take a big jump during a short squeeze.
Here’s an example:
Check out the short statistics on Angie’s List Inc (ANGI).
Source: Morningstar Inc.
Generally, a short ratio above 5 indicates that a positive catalyst could trigger an epic short squeeze.
Before you consider shorting a stock, look at the short ratio, or days to cover, for an idea of the potential strength of a short squeeze. Remember that this ratio is not exact — trading volumes often fluctuate wildly when shorts get squeezed — but it’s always worth knowing.
Jeff Bishop is lead trader at TopStockPicks.com. He runs short-term trading strategies, using stocks, options and leveraged ETFs.