Fails if: Current Short Interest Ratio is 3 days or more, and has increased over the past month.

Short Interest Ratio is the number of days it would take to buy back all the company's shorted shares, if purchased at a rate equal to average daily volume.

This Risk Alert tells us that members of the investment community have become more skeptical about the stock's prospects. Because short selling can be especially risky, we can assume a greater degree of bearish conviction than is the case when investors simply sell existing positions or avoid the stock.

It is therefore important that you investigate to determine why short interest is rising.

Sometimes, the answer will be obvious such as recent estimate revisions, ratings downgrade or a price rally that gives much cause to believe the stock is overvalued.

Other times the answer isn't so clear. Rising short interest might mean investors are skeptical about a company's ability to maintain a strong growth rate, a prospective new product, an expansion program, an acquisition, management turnover, etc [Key Developments].

To calculate the days it takes to cover shorted shares we calculate the ratio of the number of shares sold short to average daily trading volume [Short Interest].

It's easy to see if the rising short interest is based on reduced trading volume. All you need to is check the Shares Shorted reports for each stock and see whether or not the number of shares sold short rose over time. If not, then falling volume is probably the culprit. Assuming the recent trading activity is sufficient to maintain reasonable liquidity for the stock, this Risk Alert would not likely present a substantial concern.

Other increases in the days to cover shorted shares are important. Make sure you search for the reason. It is perfectly reasonable for you to disagree and decide that you'll continue to hold, as there are situations where stocks have continued to rise for prolonged periods. But it is not reasonable for to you to continue to hold without knowing why short interest is on the rise. If you do a diligent analysis and are still unable to discern reasons for the increased market skepticism you may want to err on the side of caution.

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