Every short seller anticipates a declining stock market. Investors sell short stock when they anticipate its price going lower. Sooner or later they must cover their short sales by buying back the stock. A profit is made if the stock is bought back at a lower price than when it was sold short. When a large amount of short selling activity is occurring, market participants obviously expect prices to head lower. The NYSE Short Interest Ratio is therefore a long-term contrary opinion sentiment indicator. It is calculated by dividing the monthly short interest figure released by the New York Stock Exchange by the average volume of trading per day.
These numbers get sometimes distorted by arbitrage transactions, but the short interest ratio is nevertheless a good indicator of optimism or pessimism in the market. Short sellers are potential buyers sooner or later and represent a lot of buying power when they have to scramble for cover in a sudden market turn. Contrary indicators require at least some degree of pessimism in order to function and therefore you should watch this ratio very carefully.
Bullish: High readings
Bearish: Low readings
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