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The Secret Ingredient for Higher Stock Prices

Adam Sarhan
Tue Jul 15, 2014 12:57 EST

Basic Wall Street Lingo
 
The bulls want the market (or a stock) to go higher, and the bears want the market (or a stock) to go lower. Typically, the bulls go "long," and the bears go "short" in order to express their view. The most common way of measuring the bearish side is to look at short interest. 
 
What Is Short Interest?
 
Short interest is the percentage of shares sold short versus the number of shares outstanding. For example, 2% short interest means that 2% of the outstanding shares are held short. 
 
Fuel For the Bulls:  Short Covering
 
Keep in mind there is only one way for a market (or stock) to go up: there are more buyers than sellers. That can occur in two ways -- either new buyers show up and buy shares for one reason or another and think that the market (or the stock) will head higher after they buy or the second set of buyers are short sellers who are throwing in the towel and covering their position. When you short a stock the only way to exit your short is to buy the shares you sold. So, as the market rallies, the short sellers' losses grow, and they eventually exit their positions. This new set of buyers helps send stock prices higher and is known as short covering. 
 
The Most Hated Rally in History: Why S&P 500 Short Interest Is Surging
 
The current bull market is known as the most hated rally in history because virtually no one believes that this market should continue to rally and deserves to be here without massive support from global central banks, which will eventually end. So invariably, what happens is that people show up and try to short this market. The problem (for them) is that the market continues to rally and keeps going up (proving them wrong in the process). Eventually, they will need to cover their short position, and, as previously mentioned, that adds new bullish fuel to the fire. 
 
S&P 500 Short Interest Is at Record Highs
 
Short interest in the average S&P 500 stock is at the highest level since September 2012, which could actually serve as a contrarian indicator as this market continues grinding higher. If one were to look at all the stocks in the S&P 500, the median stock has a short interest of 1.73%, which is higher than the average median short interest, and much higher in certain stocks. 
 
Bottom Line: Don't Fight the Tape
 
There are many reasons why the market "should" be doing one thing or another. Keep in mind that successful traders know how to filter out the noise and focus on what matters the most: the facts, namely price action. The best way to study the facts is to look at the price action of the market. Right now, we are in a very strong bull market, and the path resistance is higher until this very strong bull market ends. I've learned a long time ago to trade on what I see happening and not on what I think should happen. 
 
 
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