Short Sellers Are Questioning the Rally

Tuesday, 28 Sep 2010 08:55 AM

By Rick Pendergraft

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While the market has been rising over the last four weeks, the short interest ratio for the S&P 500 SPDRs has been rising for the last four months.

The short interest ratio measures the number of shares sold short, divided by the average daily trading volume of the stock in question.

With the Spyders, the ratio has been rising for two reasons.

The number of shares sold short has been on the rise since the beginning of May.

On May 1, there were 282 million shares sold short and the short interest ratio stood at 0.80. As of September 15, the number of shares sold short reached 318 million and the short interest ratio jumped to 1.8. This is the highest reading on the short interest ratio since the peak in the market in mid-April.

The ratio can rise for two reasons: first, the number of shares sold short could increase while the average volume remains constant. Secondly, if the number of shares sold short remains constant and the average daily volume dips, the ratio will rise as well. In the current environment, the dip in volume may be having more of an impact than the actual increase in shares sold short. This summer’s volume was very low in the overall market and that is reflected in the volume on the Spyders as well.

As a contrarian, I would normally look at an increase in the short interest ratio as a bullish sign.

However, over the course of the last year the short interest ratio has peaked when the market has peaked and the short interest ratio has bottomed when the market bottomed.

If the short interest ratio starts declining in the next few reports, we could see the market pullback as well.

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