Does short-selling data give any indication of future market direction? Let’s delve into the topic using historical data from the past 15 years.
There are more than 800 shortable stocks in Hong Kong. The short-selling ratio of the market refers to the percentage of daily turnover related to the short-selling activity on those stocks.
For example, the overall short-selling ratio was 10 percent on Tuesday, which means of the HK$76 billion market turnover, about HK$7.6 billion was related to short-selling transactions.
One would typically assume higher short-selling activity means investors are becoming more bearish.
But does that mean the market actually weakens when short-selling is rampant?
Historical data suggests that is not the case.
Based on data from more than 4,000 trade days since 2000, there were 1,300 instances when the short-selling ratio hit 8 percent or above.
In slightly more than half of those cases (53.3 percent), the market actually gained in a month’s time.
In fact, when the short-selling ratio hit extremely high levels, like over 12 percent, investors were usually better off buying instead of selling.
A possible explanation is that many individual investors tend to start short-selling when it’s too late — the market has already suffered heavy losses and a short squeeze is around the corner.
In a recent example, the overall short-selling ratio soared to 15.9 percent on Aug. 22, the highest for more than two months.
Subsequently, the benchmark Hang Seng Index kept rising and the short-selling ratio retreated to 10 percent.
The short-selling ratio is hence more useful as a reverse indicator.
When it is hitting high levels, that should be read as a buying opportunity.
This article appeared in the Hong Kong Economic Journal on Sept. 8
Translation by Julie Zhu
[Chinese version 中文版]
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