Three Risks Every Short-Seller Must Know

Short Interest. This represents the total amount of shares currently short. Short interest is reported to and disseminated by the stock exchanges, such as the NYSE (NYX Quote) and Nasdaq (NDAQ Quote) on a monthly basis (see "How Do I Find Short Interest for a Stock?"). This is an absolute number, which is not important in and of itself, but it is the first component in calculating the next metric, the short ratio.

Short Ratio. The short ratio is sometimes referred to as the "days to cover." This ratio represents the amount of days (on average) that it will take for all short-sellers to cover ("buy-in") their short positions. It is calculated by dividing a stock's short interest by its average daily volume . The higher the ratio, the more risky it is to short the stock, because it will take the short-seller a longer period of time to cover the short than for a stock with fewer days to cover.

Please be cognizant of the fact that the short ratio assumes that in the event that all shorts were to cover, they would do so to the exclusion of long buyers. Thus, in reality, it will take more days to cover all shorts than the short ratio implies.

Short Percentage of Float. This represents the percentage of a company's available stock float , which is already short. The greater this percentage, the greater the implication of the likelihood that the stock is a "crowded" short -- one that is heavily shorted. A higher short percentage of float also portends that the availability of stock to borrow could be in heavy demand and limited supply.

Don't get "short squeezed." Analyze these metrics carefully before you initiate a short sale.

Homework Time

This closes out my series on short-selling. By now, you should have a grasp of the essentials of what's involved in shorting stocks and how to do it. However, that should not preclude you from doing some homework:

• For a short sale that you have on or are considering, identify the short interest, short ratio and percentage of shares short.
• Observe a buy-in.
• Observe a short squeeze.