Short Interest Ratio vs. Short Interest

 

Let's start with some basic definitions to be able to understand the market today:

Short float definition

Investors who wish to personally manage their shares portfolio will encounter various share market metrics that can guide them in determining how a company’s share price could move. One of these guide metrics is called the short float or short percent of float.

Short float is defined as the percentage of shares in the market that are shorted in relation to all shares in a float. Many active traders consider this percentage because it can indicate whether they can make a profit from trading a share. Beginners can also benefit from understanding short floats.

Nest Egg provides a quick guide to help beginner investors understand the significance of a short float and the information it provides about a share.

What is ‘float’?

Float refers to the total number or percentage of authorised shares that has already been made available in the share market for public trading.

There are different types of float shares and each one has conditions and rights attached. Nest Egg’s What are the different types of shares? explains the differences in further detail.

What is ‘shorting’?

Shorting refers to an investment strategy that involves borrowing shares from a broker and selling them for a profit then buying the same number of shares to return to the broker. However, the strategy isn’t as simple because shorting involves betting that a company’s share price will go down then borrowing the shares to sell at its current high price.

If the investor was correct and the share price declines, they would purchase the same number of shares at a lower price to return to their broker. This scenario would result in a profit once the investor closes their position.

However, if the share price increases and the broker calls for the investor to return the borrowed shares, the investor would have no choice but to purchase higher priced shares to close their position. This would result in loss for the investor.

What information does a short float reflect?

Short float shows the percentage of shares that are shorted relative to the number of float shares and this percentage reflects the market sentiment about the underlying company.

Since investors who short shares assume that the share price will decline, a high short percent of float implies that investors are either bearish on a company or they believe it is overvalued and they intend to profit off its potential decline by selling high.

How can beginners benefit from the short float information?

Beginner investors must learn that not all price movements are indicative of the underlying company’s performance simply because many experts are executing the trades. They have to be wary of the potential intent behind a price surge or decline before joining the bandwagon because they may end up being swept away by mere market sentiments.

Instead of blindly following a trend, beginners should consider searching for information regarding a company’s float shares and the proportion which is shorted—or those that were simply borrowed and sold. This percentage would give them the idea that a company may soon see a drop in their share price and that they could incur loss.

However, it’s also inadvisable to rely solely on the short float when making investment decisions because it is only one of the many metrics experts use.

Nest Egg recommends that investors practice due diligence before making an assumption and executing trades over a share’s price movement.--------------------------------------------------------------------------------------------------------------

Types of company shares

Companies issue shares to raise capital for funding business objectives. Each type of share has a different purpose, and the conditions for owning them vary.

There are five types of shares companies are allowed to have: authorised, restricted, float, unissued and outstanding. These are explained below:

Authorised shares: the total number of shares companies are allowed to have. This number was determined prior to the initial public offering and it usually does not change unless voted on by relevant parties.

Restricted shares: as its name suggests, restricted shares are stocks intended only for the company’s owners (i.e., founders) and employees. This may be given as an incentive or as part of the employment package, and restricted share owners are not allowed to sell the stock they own unless permitted by the Australian Securities and Investments Commission (ASIC).

Float shares: these are shares issued by companies for public trading, which means this is what investors trade in the stock market.

There are different types of float shares which are traded with accompanying conditions and rights for shareholders, but these will be discussed in the next section.

Unissued shares: exactly as its name says, unissued shares have not yet been issued as either restricted or float shares. This may be issued at a later time— perhaps when the company needs to raise funds again—or simply kept in the company treasury.

Outstanding shares: This is the total number of issued shares or the sum of restricted and float shares.

Equity Shares: According to Nestegg, "Equity shares refer to ordinary or common shares issued by the company for public trading. These equity or common shares come with voting right and dividends, but dividend payouts are not always guaranteed and voting rights usually depend on the class of common shares purchased."