12 Keys to Trading Earnings for Profits

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#9 Short Interest

Monitoring short interest is an effective method for deriving valuable sentiment data for stocks.  Short interest is created when an investor sells borrowed stock.  The strategy is profitable when the price of the shorted stock declines, allowing the short seller to buy the stock back at a lower price.

As short interest is a bearish strategy, monitoring semi-monthly short-interest figures provides a glimpse of the level of pessimism toward a security.  In most instances, large amounts of short interest indicate a negative general outlook. 

Besides serving as a contrary indicator, short interest has a mechanical component that an investor can exploit.  If a stock's price is rising, short positions are losing money (in fact, short players have unlimited risk).  This often causes the shorts to close their positions by buying back their shares.  This added buying pressure forces the stock price even higher (known as a "short squeeze"), which in many cases makes the uptrend persist longer than most would anticipate. 

We especially like heavy short interest on a stock displaying strong price action with pullbacks contained at key support levels.  This is where you will potentially see quick, significant moves caused by short-squeeze buying among the shorts looking to limit their losses.