The short interest barometer

INVESTING

Susheel Sheth loves playing the contrarian: He buys when others are selling (in a falling market) and sells when others are adding to their equity portfolios.

But his first love is short selling, he confesses.

He makes money by going short on counters that he feels may decline in the near term, specially in counters that are available in the derivatives segment.

His modus operandi is simple: He keeps a close watch on companies that show a sudden spurt in prices, specially on the back of news and then goes short in the F&O market. He has finetuned this strategy to extract maximum benefit at a minimum cost "" read losses.

And when he feels very strongly about certain companies, he borrows the shares from a broker and sells them in the market, hoping to buy back at a lower price.

Since the margin lending and borrowing system is not very well used in India, borrowing sometimes becomes a bit of a problem, he says.

Sheth is not the only one using the short-selling strategy to make money.

Short-selling allows a person to make profits from a falling stock and is used as a strategy effectively worldwide.

Market sources said that the ability to short sell a stock should not come as a surprise as stock prices are constantly rising and falling.

In fact, investors tend to keep a close tab on short interest: literally a market-sentiment indicator of stock trends.

Short interest indicates trends

The ability to short-sell a stock comes from the fact that stock prices are constantly rising and falling.

In fact, broking houses research companies are not only looking for multi-baggers (shares that increase in value by more than 100%) but also for prime short-selling candidates.

These are typically companies with weaknesses that the market may not have discounted yet or a company that is simply overvalued.

They also look at the short interest, which serves as a market-sentiment indicator.

Market entities define short interest as the total number of shares of a particular stock that have been sold short by investors but have not yet been squared off.

This can be expressed as a number or as a percentage. When expressed as a percentage short interest is the number of shorted shares divided by the number of shares outstanding.

Short interest allows investors to gauge overall market sentiment surrounding a particular stock. Typically, a large increase or decrease in a stock's short interest from the previous month can be a very telling indicator of investor sentiment.

In India, where most of the action is in the derivatives segment, players keep a close watch on the open positions and then plan their strategy.

Investors usually tend to take their short-term calls in the cash segment according to the trends in the F&O market.

Besides having naked positions, positions without taken any underlying shares, they also use it to hedge their positions.

What's short-selling

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Short-selling is the opposite of buying stocks "" it entails the selling of shares that the seller does not own in the hope that the price will fall. Market players can borrow the stock from their broker-dealer, sell it and get the proceeds from the sale.

If, after a period of time the stock price declines, they can close out the position by buying the stock in the open market at the lower price and return the stock to the broker, making a neat profit in the bargain.

But there is a catch: if the stock price rises, you lose money since you have to buy the stock back at a higher price.