Short Sellers May Have Fueled Rally

Bearish traders continued to boost their bets on lower stock prices as of mid-March via “short sales,” new data show.

The surge in such stock sales may have helped set the scene for the broad market rally since March 11, as some of those traders changed their minds and rushed to buy stocks to close out their bets.

The Nasdaq Stock Market said Tuesday that so-called short interest -- the number of Nasdaq shares that had been borrowed and sold -- jumped to 4.335 billion as of March 14, up 3.5% from mid-February levels.

The mid-March total was just 583,000 shares below the record level of Nasdaq short interest reached in mid-July.

In a short sale, a trader borrows shares (usually from a brokerage’s inventory) and sells them in the open market. The bet is that the share price will decline, allowing the trader to buy the stock back more cheaply at a later date.

If the bet is correct, the trader pockets as profit the difference between the initial sale proceeds and the repurchase price.

Short sales surged in 2000 and 2001 as the bear market on Wall Street raged, tempting more traders to try to profit directly from falling stock prices.

As the market rallied late last year, short selling began to wane. But a renewed decline in share prices in February and March encouraged more traders to sell stocks short.

The New York Stock Exchange last week reported that short interest in its stocks rose to 7.996 billion shares as of March 14, up 4.3% from mid-February.

The jump in short sales meant many traders would have been caught in a bind when the stock market began to rally March 12. If share prices continue to rise, short sellers risk unlimited losses until they buy back stock and close out their trades.

That is why high levels of short interest can help fuel market rallies: A rebound in prices can pressure short sellers to terminate their bets by repurchasing stock. Their buying, in turn, can add to the market’s gains.

The Dow Jones industrial average has risen 10% since March 11; the Nasdaq composite index is up 9.4% since then.