Record Short Interest Prevents Correction

Wednesday, October 25, 2006 | 06:09 AM

If you are at all curious as to why the market keeps powering higher, you can look at several factors: Falling energy prices, lowered interest rates, increased futures buying are likely culprits we have identified as impacting intermediate term trading.

But don't overlook THE key short term driver for why the market has a "preternatural bid" beneath it:  Record Shortselling.

According to today's WSJ, "Short-selling activity rose to a new record on the technology-stock-heavy Nasdaq Stock Market, outpacing the rise in bearish bets in other parts of the market."

"For the monthly period ended Oct. 13, the number of short-selling positions not yet closed out at Nasdaq -- so-called short interest -- rose 0.8% to 7,414,701,519 shares from 7,353,774,333 shares in mid-September.

The rise outpaced the 0.1% increase in short interest at the neighboring New York Stock Exchange, which as previously reported also saw its total short interest hit a record in the October period.

Despite a market run-up that has pushed the Dow Jones Industrial Average to records this month, many short-sellers have hung onto their bets, which lose value during such upturns...

The Nasdaq short ratio, or number of days' average volume represented by the outstanding short positions at the exchange, fell to 3.9 from 4.4 last month."

The record short selling manifests itself in several ways in actual trading.

From a Sentiment perspective, it means that we have not achieved a giddy excess bullishness required for a correction. 

And, as long as short positions are at all time records, its hard for any correction to develop. Any downside momentum is simply halted by covering. And exasperating things, each move upwards becomes exaggerated as shorts stop losses get triggered and they buy in.

Of course, this can change in a hurry: words or deeds from the Fed, oil prices, geopolitics, even an errant comment from Treasury Secy can start a cascading chain reaction.   

Consider this: if the rabid anti-shorting Sith Lord crew get their way, they will have succeeded in removing a key floor to markets, and source of buying when we correct.

Despite my Macro-environment Bearishness, I have been telling clients that it is still too early to short, given the technical picture. Short interest only adds to that.


UPDATE: October 25, 2006 7:28am

For a timely example of how short interest can impact a stock, Marketwatch's Bambi Francisco notes that:

Amazon (AMZN) shares shot up 11% in after-hours action, partly on relief the retailer didn't blow its quarter, and to a great extent because those who sold Amazon short prior to the results had to run for cover. Amazon's short interest stands at the highest level in at least a year. According to the Nasdaq, 43.6 million shares are held in a short position.

That's a perfect example of how a crowded short position places a floor under a stock or market . . .


Bearish Bets On the Nasdaq Reach a Record
Increase Reflects Concerns Of Lingering Weakness
Despite Recent Stock Rally
WSJ, October 25, 2006; Page C11

Wednesday, October 25, 2006 | 06:09 AM | Permalink | Comments (41) | TrackBack (0) add to | digg digg this! | technorati add to technorati | email email this post



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Doesn't this also mean we have the potential to go much higher if we have another leg up and these shorts get scared out and cover fueling us even higher?

Posted by: Adam Schierholz | Oct 25, 2006 7:18:04 AM

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