Thursday, July 7, 2011

Are short sellers an issue?

So far today, CNIT is holding up reasonably well. Monitoring it today, I came across an article that claimed that CNIT, among a few other recent big gainers, raises "red flags". The only thing it has against CNIT is that, as with other stocks that obtained their US listings through reverse mergers, it has over the past few months been the target for lots of short sellers. I will look into how I feel about reverse mergers later, but for now let's evaluate the risk posed by short sellers on CNIT, with data rather than feeling.

The chart below, obtained using data from Nasdaq, shows CNIT short interest (in # of shares) vs. average daily volume for the corresponding period.



And this next graph shows the short interest ratio (or "days-to-cover ratio"), shows the short interest divided by the average daily volume. The short interest ratio tells us how many days it takes for short sellers to cover their position if it gains strength. The lower, the better for bulls and anyone who's long.



What's interesting is that, pretty much for an entire year, the short interest on the stock has been declining (graph 1). However, because volume wasn't picking up, the short ratio continued to have spikes in late 2010, and stayed pretty solid up until March. Then suddenly volume picked up and while short interest wasn't declining any faster, the short sellers needed to cover their positions much fast.

Finally, we see what happened in late May with a sudden massive surge of short sellers coming in to feed on perceived negative news. This quickly changed when buyers came back in and everyone realized that bad news wasn't all that bad. Now we're at a point where the short ratio is 1.25 and falling, and volume has been increasing comfortably.

I'm guessing once we have data for July, given the increase in volume and bullish trend reversals, that we'll see average daily share volume surpass short interest, causing the short interest ratio to dip under 1.

It remains to be seen whether there will be another surge of short sellers, but the trend so far is positive for CNIT.

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