S horts, floats, interest, ratios, closing, borrowing… the world of short selling is not for the faint of heart. If you want to venture into the realm of profiting off of dropping stock prices, you’ll have to get a handle on the vocabulary of short selling, including understanding short floats.

Takeaways:

• Shorting stocks is an advanced investment strategy.
• Floats represent a specific subset of a company’s shares.
• Short floats are a percentage of the overall float.
• Short interest ratios can help investors decide whether to execute a short.
• Short squeezes occur when the market goes up instead of down.

Shorting a Stock

Image via Unsplash by Annie Spratt

Before we can get into short floats, we’ve got to start with shorting stocks. Stock shorting is an advanced trading strategy that relies on a stock’s value dropping. The lower the stock drops, the more money the investor stands to make. Here’s how it works:

1. Borrow shares: The investor borrows shares (this is important — you can’t short with stock you own), usually from a broker-dealer.
2. Sell the stock: Then, the investor sells the shares. At this point, the stock is in a ‘short float’ (more on that later), where the short is not yet closed out or covered.
3. Buy back the stock: Next, the investor waits for the stock price to drop, and once it does, they purchase it back at a low price. This is called closing out.
4. Return the stock: To complete the short, the investor returns the shares to the original owner and keeps the profit they made by selling high and buying low.

The Free Float

You’ll hear the word ‘float’ used as investors assess the value of stock or its viability for shorting. Two common types of floats are free floats and short floats. A float, or a free float, is the total number of tradable shares of a company’s stock. It’s an important number, since it’s used to determine metrics like short interest, short percentage of float, and short interest ratio.

The Short Float, or Short Interest

The short float is a percentage which evaluates the number of shorted shares in relation to the total number of floated shares. This metric is more commonly known as short interest. In theory, the maximum of a short is the same or equal to the free float, but in reality, this percentage rarely goes over 50%, though there have been examples historically where it’s happened. In most cases, a ‘high’ short interest is anything above 40%. If you see that number, look for a coming short.

It’s important to remember that the short float indicator refers to stocks which have sold short, but which investors have not yet covered or closed out. The New York Stock Exchange publishes short numbers twice a week for investors to use as they make buying and selling decisions.

Calculating the Short Interest, or Percentage of Float

To find the short percentage of a float, take the total number of shares shorted and divide it by the total amount of shares available for trade. This metric, despite what the name might imply, can be expressed as either a percentage or a number.

As an example, if 10 million shares are shorted with 30 million available floated shares, the short interest would be 10 million divided by 30 million. As a number, the short interest is 0.33, while as a percentage, the short interest equals 33%. The maximum possible number of shares investors could short would be 30 million, or the total free float.

Short Interest Ratio

The short interest ratio is another useful metric. To find it, take the short float, or the number of shares sold short, and divide it by the average daily volume for that company. This ratio is also known as the days-to-cover ratio, because it expresses how many days it’ll take short sellers to cover their positions if the stock heads back up in value.

For example, let’s say a company’s short float is 20 million shares, and the company’s average trading volume per day is 10 million shares. If we divide the short float of 20 million by the trading volume of 10 million, we discover that it would take two days for short sellers to cover their positions. Most traders try to avoid ratios of over eight days, as those present too much risk.

Using the Short Interest

Understanding the short float or short interest and corresponding metrics like short interest ratios can help you determine the potential risk and likelihood of payoff when considering a short. However, it’s important to use short interest carefully — it’s not great as a solo indicator. High short interest could mean a couple of things:

• The company is in decline: The company could be in major decline with little hope of an uptick in value, making it a great short opportunity.
• Investors anticipate a drop and a rebound: Conversely, the company could be facing a momentary drop in value with an anticipated increase in price.

Shorts are tricky. You can never be entirely sure what a high short interest indicates, so consider looking at other factors like company fundamentals and technical indicators to give you a clearer picture of the company’s overall health and where its stock valuation could be heading.

Understanding the News

Finding the right time to short depends primarily on the health of the company, which you can’t always quantify neatly in a metric or ratio. While these calculations can tell you how many people think the stock will decline, studying news reports which give qualitative information about the company, its leadership, product development, and other intelligence is the best way of determining whether or not a short is coming.

The Short Squeeze

A short squeeze is one of the biggest risks to taking a short position. A short squeeze takes place when a stock you have not yet covered or closed out moves up in value rather than down. In this case, short sellers must quickly close their positions to keep their loses to a minimum, but in doing so, they drive the price of the stock up higher.

Short squeezes are most common in small-cap companies, where there’s a small float to begin with, but mid-cap and large-cap companies are not immune to this phenomenon, either.

Short Selling Tips

In addition to keeping an eye on short floats and short interest ratios, keep these short selling tips in mind to help you have the best chance of success and the highest possible return on your investment:

Don’t just rely on valuation

You need to look at more than one metric, plus learn as much as you can about the qualitative value of the company, before you decide to short. Valuation can be a great tool, but it’s not the only tool you should use.

Stick to the low numbers

Attempting to short very expensive stocks could end in huge losses if the company’s value goes north. Instead, stick with lower value stocks so even if the market doesn’t work in your favor, you won’t lose a tremendous amount of money on your bet.

Watch for the sucker short

A sucker stock is one that has a huge, surprising rise in value. With a meteoric rise, lots of investors assume it has to drop and try to get their short moving. However, it could keep going up. Wait these out and don’t get in the game until the stock is on its way down.

Keep an eye on the moving average

You want your short to be below the 30-week moving average. It can be tempting to try to get in at what you think is the peak, but there are just no guarantees. Instead, watch the average and wait for it to drop.

Check the volume

Generally, you want to short less than 1% of the total daily volume. If a stock has a low volume, even if it looks like a good bet for a short, the risks might outweigh the potential returns. Many investors won’t short a stock with less than 500,000 shares traded daily.

Look for weakness

You’re going to want weakness in three areas — overall market, specific industry, and actual stock. Those situations are the short seller’s dream. If only one area is weak, you’re better off waiting. If two areas are weak, it could be worth considering, but take a look at other metrics, too.

Use a protective stop

A protective stop is a type of limit order that can help you avoid substantial losses on a failed short. For example, if you wanted to short a stock, but are worried about a reversal in trend, you could place a limit order for the maximum amount of money you’re willing to lose, so you’ll get the stock you need at the price you want. In the case of a short, whenever possible, you want your protective stop to break even.

Short on the way down

Lots of investors get greedy and want to maximize their profits by trying to time their short with the peak of the stock’s valuation. It rarely works. Instead, wait until the stock is actually headed down before pulling the short trigger. You may lose out on a few bucks, but it’s better than getting stuck with a stock that just keeps rising.

Use charting patterns

Charting patterns can help you identify opportune moments to short a stock. Useful patterns to look for include bearish reversal patterns like head and shoulders, evening star, shooting star, hanging man, and dark cloud cover.

Look out for seasonality

Short selling during the holidays is often a fool’s errand. Even though stock value can rise tremendously during this time, it’s hard to predict exactly when it’ll end. Wait for calmer, less seasonally affected times to play the shorts.

Find the hidden gems

Those big-name, highly public financial meltdowns tend to attract a crowd, and could result in a short squeeze. Instead, look for less-well-known company collapses to short.

Understanding short floats, using short interest, and calculating metrics like short interest ratios can go a long way in helping you identify successful shorts and pulling in a nice profit. However, it’s important you don’t solely rely on these numbers. Use other factors to help you determine the right moment to make your play.

More importantly, I have an undeniable passion to pass along my knowledge to others.

During my live trading presentation, I pulled out two picks to introduce the service – SDC and YETI calls.

These were my highest conviction trades based on my LottoX indicator.

How did those two trades perform?

First thing the next morning…

Not too bad for my first set of alerts in LottoX!

You’re probably wondering what made these stocks special? And what compelled me to pull the trigger?

Believe it or not, I used techniques you’re probably familiar with. However, I might not use them in ways you’re accustomed to.

Let me explain…

Trade With Strong Trends

You probably heard the saying ‘the trend is your friend.’ It’s actually true.

Trading against the trend is like salmon swimming upstream. I found out long ago that it’s much easier to trade in the direction the stock wants to move then pick off tops or bottoms.

One question I often get is how I identify trends. I wrote about this a while back in my newsletter Spotting Trends the Right Way. To boil it down, you want to look for stocks where the direction is obvious.

This is a classic uptrend.

AAPL Hourly Chart

If you saw a stock trading this way, it wouldn’t make much sense to try to short it. That would make your life very difficult.

Similarly, you wouldn’t want to bet on a turnaround in this stock.

BBBY Hourly Chart

You might get lucky and pick the turning point. But chances are you lose money instead.

When you look at a chart of SDC, you can see how it has a nice uptrend off the bottom.

SDC Hourly Chart

YETI had a similar look with a push higher recently.

YETI Hourly Chart

Create a List of Stocks

I like to trade stocks that move around a lot. These wide ranges give me an opportunity to pick up explosive moves in the options.

What I consider a ‘wide range’ is relative to the stock’s price. A $15 stock that swings around $1 daily is more interesting than a $150 stock that swings around $1.

I tend to keep a list of stocks that I like as my ‘go-to’ for picking out trades. This list includes charts that I like, ones with nice volume on the options, and easily identifiable trends to work with.

If you’re having trouble coming up with names, check out my newsletter on how to slim down your watchlist.

Look For Price Consolidation

Explosive moves out of stocks start with areas of consolidation (otherwise you’re trying to play reversals which I don’t do). I look for charts where the trading range for a price compresses as it goes on.

When price starts to compress, it means that energy is building to break out of the consolidation range. The longer and narrower the price channel, the more explosive the move.

That’s how I played SDC and YETI. Check out how the SDC hourly chart shows price consolidating in a range after a large up-move.

SDC Hourly Chart

Notice how price started trading in a narrower range after the big push higher. That normally leads to another leg moving off in the same direction.

Use Options to Your Advantage

Most traders start and stop with buying and selling stocks. They rarely dabble in the world of options. Half the time it stems from misconceptions around the products.

Here’s the thing. Options offer leverage for trading stocks. When used responsibly, they make your capital usage more efficient, not less.

Consider the following – you want to trade 100 shares of YETI. If you bought 100 shares it would cost you $3,800. A call option that controls 100 shares of stock cost me $120. 

Don’t get me wrong, I pay a premium for the right to use that leverage. But I’d rather risk $120 on a stock then $3,800. Look no further then Tesla as to why. The last thing I want is to wake up one morning and find a stock I hold cut in half or worse.

What Is an Options Screener

An options screener is an effective filter for when investors have specific ideas about the types of companies they want to invest in. With thousands of stocks available on U.S. exchanges alone, it’s not feasible to monitor and track them on their own. A stock options screener pinpoints stocks investors see to those meeting their unique sets of data. Option screener software has three essential components:

• A database of stocks and companies
• A collection of variables
• An option screening engine that locates companies that meet set variables while generating a list of matching options to choose from

Using a Stock Option Screener

An effective options screener allows traders to search using just about any criterion or metric they wish. Once an investor inputs their information, they receive a list of stocks meeting those requirements. Using a stock options screen is relatively easy and starts by answering questions such as:

• Do you prefer small-cap or large-cap stocks?
• Are you searching for companies that have stocks that have fallen in value or stocks with prices at an all-time high?
• What price-to-earnings ratio (P/E) range are you comfortable with?
• Are you searching stocks within a specific industry?

By keeping the focus on measurable factors that affect the price of a stock, a stock options screener helps investors do quantitative analysis, or screening tangible variables including profit margins, volatility, revenue, and market capitalization in addition to performance ratios like debt-to-equity (D/E) ratio or P/E ratio.

Knowing What to Screen For

The most prominent challenge investors face when using a stock options screener is identifying what criteria to include in their search. With hundreds of variables to choose from, the sheer number of possible combinations is endless.

While options screeners are very flexible, if an investor doesn’t know what they are looking for or why they are looking for it, options screener software won’t be able to provide much help. Some options screener sites have predefined stock screens available for investors to use, which already have basic variables entered.

Some options screener sites offering predefined screens favored by experienced investors are listed below:

• Yahoo! Finance offers three predetermined screens, including Portfolio Anchors, Day Gainers, and Undervalued Large Caps. Yahoo! Finance lists and explains the search criteria used for each screen to help users understand the underlying principles of each of the screens.
• MSN Money includes several popular screens which can be furthered sorted and filtered by category.
• FinViz provides a signal drop-down menu allowing users to filter criteria such as wedges, top gainers, and recent insider buying.

Watch Out for These Limitations

While a stock options screener can be a handy tool, they do have limitations that investors need to keep in mind:

• The majority of options screeners only include quantitative factors, with many qualitative factors left to consider. No stock options screener provides information on things like customer-satisfaction levels, pending lawsuits, or labor problems.
• Options screeners utilize databases that are updated on various schedules meaning investors must check the timeliness and relevance of all data. If an options screen is providing outdated or irrelevant data, the search could be meaningless.
• Be aware of industry-specific blind spots like very few tech companies showing up when searching for low P/E valuations.

Do Your Research

While investors are often thankful for tools such as stock options screeners that can make life easier, it imperative to remember nothing beats doing individual research. Just because an options screener provides investors with a stock list that meets their criteria, it’s essential to take all this information with a grain of salt.

A stock options screener doesn’t know about news potentially affecting some companies. Investors need to use this information as a starting point and working from there. Take time to read up on any economic or legal issues affecting companies listed, anything that can make a dent in their bottom line.

Free Options Screener Options

Free stock options screeners are valuable resources for searching for the right investment as they can help narrow information and provide investors with a place to begin when selecting the best stock for them.

• Yahoo Finance Stock Screener
  An excellent place for investors to begin their investment research with a home page providing detailed stock market information, including current market conditions being live-streamed for Standard & Poor’s 500 Index, NASDAQ, and the Dow. It also includes information on the value of the U.S. dollar against the euro and current oil and gold values.Once investors receive information on the current state of the market, they can continue to narrow their search by index membership and category before tightening it even further by entering specific share data, they are looking for, including dividend percentage and maximum and minimum prices. Finally, they can filter growth estimates, sales, and valuation ratios. Once done, the best matches are generated by clicking the “Find Stocks” button.
• Fidelity Stock Screener
  Investors don’t need to be a Fidelity customer to use its very detailed options screener. While it does have a slightly higher learning curve, there are video tutorials available. In addition to the standard options like dividends and price, the Fidelity options screener provides investors with a list of the most popular search information other traders are using while letting them filter options based on the growth potential and company value. Fidelity also offers several predefined screens. Investors can click on a category to see the entire list of investments recommended.
• CNBC Stock Screener
  CNBC’s stock options screener provides investors with the option to create custom screens or use predefined screens for steady performers, high dividends, and small-cap values. Criteria are organized into nine different categories, including performance history, analyst estimates, growth trends, and more with filters available for investors to narrow their search even more.

Paid Options Screener Options

If an investor is ready to get serious about trading, they need to find a great stock options screener with most experts agreeing that paying for an options screener isn’t a waste of money. Using a high-quality screener typically provides investors with high-quality results. Paid stock options screeners to consider include:

• TradingView Stock Screener
  A web-based charting software, TradingView offers investors with excellent charts and a stock options screener with many fundamental and technical criteria combinations investors can use to located trading opportunities.Many investors like that TradingView covers world economic data, Forex, Futures, and International stocks. At least 39 International stock markets are covered, including several European countries, Japan, Singapore, Hong Kong, Australia, Canada, and the UK. Other useful features include a fundamental stock screener with an excellent range of fundamental criteria for investors to select from, a technical stock screener with several technical indicators to further refine a search, Forex screener, and Cryptocurrency screener.
• Finviz.com
  Another web-based stock options screen, the Finviz.com screener, helps investors find potential stock trades easily and quickly. While charting software of the past usually only offered technical criteria for options scans, Finviz.com does an excellent job of combining both fundamental and technical data. An excellent tool for investors looking to do more in-depth research into stocks with features including premarket screener, ability to export scan results to excel, stock chart patterns screener, and financial and news statement links.

The Bottom Line

Stock options screeners are not a magic pill for finding the right stock and should never replace careful research and continued experience.