Bloomberg published an article about the activity of short sellers on American stock exchanges. Before we go any further, we will deal with open sales as we call them in Greece or better short sales as they have been called for hundreds of years in the US.
An open sale takes place when an investor who does not own the shares of a company (or any financial instrument) sells them in order to buy them back if their price falls below the price at which it sold.
To make this sale, short seller borrows shares from an investor who owns them and pays them something like rent for as long as the loan lasts. If the share price falls, then the open seller (short seller) buys them and wins as soon as he does this act, returning the shares to the one who had loaned them to him.
This is a very simple process that has existed in international stock exchanges since they were created. And in fact, it's exactly the reverse process of what those who buy shares, who borrow money to make their purchases, hope that the stock price will rise and they will sell them at a profit, while until they sell them, they pay interest to the person who has loaned them money. In both cases, of course, there is no guarantee that someone will win by following these methods, and very often the results are not at all pleasant.
Short sellers decide to borrow shares to sell them when they consider that there are serious reasons to drop the price of individual shares or because they imagine that something bad will happen in general to the stock markets. Because very often those involved in open sales are very up-to-date and experienced investors, the emergence of many short sellers on a company's stock or generally on a stock exchange is an event that does not go unnoticed. So that's what's happening these days.
In Bloomberg's article we saw that their activity in American stock exchanges is on a steady rise and has approached record levels. The size depicting open sales activity is a fraction called short interest ratio and has as numerator the number of shares sold by short sellers and as denominator the total free shares traded on the stock exchange (free float). So we saw that based on the data processed by S3 Partners LLC the short interest ratio for the shares of companies participating in the S&P 500 index was 3.62% the week that ended on 17 July, down a little from about 3.79% that occurred the week that ended on 12 June and was the highest performance since 2010 when S3 Partners LLC started processing the relevant data.
For shares participating in the Russell 3000 index, much smaller size and clearly less internationalised than S&P 500 shares, the short interest ratio is much larger, at 6,06% on July 17, with the record being at 6.28% from June 26. By observing the relevant chart, with data from Bloomberg and S3 Partners, we see that from the summer of 2024 until now there is a continuous increase in short interest ratio for both indicators since two years ago it was 2.43% for S&P 500 shares and 4.79% for Russell 3000 shares. What does that mean? We're not quite sure, but we have some ideas.
First of all, we are next to record levels for the main American stock indices, following a permanent rise that has started since October 2022 and has brought S&P 100% above then and has given similar rise to all indicators.
The great optimism that always accompanies such stock movements is accompanied by very high stock valuations in relation to their financial sizes and historical averages. In the field of technology and in particular Artificial Intelligence, things are even more extreme and it is known that many analysts and investors are systematically referring to an ongoing bubble that will not happen at any time, with great emphasis on the possibility of seeing large investments bring the corresponding profits to businesses that spend hundreds of billions of dollars annually and also to businesses that are not able to invest in the production process. «circular transactions» which are made among many of these companies and create a strange interdependence.
At the same time is the Middle East war that has created serious problems in the global energy market, fueled the rise of inflation and has overturned the situation on the front of the reference rates, with Central Banks abandoning all thought of reducing them and starting the reverse process.
Apart from these, there is a great deal of concern about the combination of the rise in government bond yields with the ever-increasing lending needs of most states and the deficits that accompany their budgets.
In short, it is quite easy to explain the increased activity of short sellers, who may no longer give much publicity to their movements, (some of the best known have retired in recent years as the continued rise of stock indices has made their work very difficult), but are still looking for shares in candidates for «shorting».
That their open sales are based on reasonable moves and thorough analyses does not guarantee their success but many of them still find goals that give them great profits, simply avoid blaspheming their open positions. But they certainly win, as it seems by the fact that in recent weeks the short interest ratio has been reduced.
The drop in the index from 3.79% to 3.62% may seem almost immaterial but in practice it probably means that some people have had a chance to buy the shares they had previously sold with good profits and obviously we are talking about positions of hundreds of millions, perhaps billions of dollars. It is certain that several of them have written good profits by selling SpaceX shares (SPCX NASDAQ) in the days after they were admitted to the stock market and buying them now that they have fallen heavily. Also, significant successes must have been achieved by short sellers who dared to sell shares of the companies that manufacture memory microchips when they saw them rising daily as crazy at the beginning of June.
Or those who had properly studied IBM's financial data (IBM NYSE) and closed their positions when the stock lost 25% within a day. Where do we want to end up? In that successful short sellers manage to cope with the difficulties of the time by studying even more the economic size, performance and prospects of businesses and paying great attention to the time points of execution of open sales.
Therefore, even without having a large fall in the main stock indices, they may derive significant profits from open sales. This does not mean that the increased activity of short sellers should not give rise to any more general concern about the progress of key stock indices. But it shows us that it is wise when their activity is growing, perhaps it is better to look more into the shares they have in their sights, the potentially large profits are probably hidden there, even if the more general stock market environment looks precarious.
