What You Should Know About Short Selling

Nasdaq companies often have questions about short selling. They want to know why it occurs and better understand the rules governing it. They ask about the information available to them and inquire about which firms are shorting their stock. Below, we’ll discuss short selling, the data available to companies and address some common misconceptions.

We should note that Nasdaq has consistently advocated for more disclosure around short selling, including in a Nasdaq Petition to the SEC in 2015 and more recently in a public comment letter in May 2022.

In October, the SEC finalized new rules requiring institutional investment managers to report certain short position data to the SEC beginning in January 2025. The SEC will publish aggregated short sale information starting in April 2025. 

What is short selling?

In a typical short sale, an investor borrows shares of a stock from a broker and sells them on the open market at current market prices, with the intention of buying them back in the future at a lower price prior to returning them to the lender. If the stock price drops, the short seller profits between the higher sale price and lower buy price, less commissions and the cost to borrow the shares. It’s buy low/sell high, just in reverse order.

Short selling is a legal investment strategy, and not all short sellers are necessarily betting against a company. Short sales can be used to hedge against other long positions, options or futures, or can be related to hedging a convertible security or an index position.

Where does an investor borrow shares to short?

An investor can borrow shares in the lending market via their prime brokerage or broker. Institutions that manage index tracking funds or ETFs, along with other long-only investors, can make shares available to borrow and collect fee thereby increasing portfolio returns. Retail brokers also allow customers to loan stock and share in the fee collected.

Just like the stock market, there is a market for loanable stock based on supply and demand. Stocks in a large index like the Russell 3000 or S&P 1500 will usually have more shares available for lending since major asset managers with index fund positions like State Street, Blackrock and Vanguard can add to the supply of borrowable shares. All else equal, stocks with low float might be harder and costlier to borrow.

Where can an investor find short selling data?

Semi-Monthly Short Position Data

The primary source for short selling information is short position data, also called short interest. This information is based on aggregated short positions in each stock across every FINRA-reporting brokerage account as of mid-month and month-end settlement dates. The data is provided by FINRA to the listings exchanges, which then publish it at 4pm on the dissemination date.

Nasdaq provides short position data in our Market Intelligence Desk (MID) Daily Reports when it’s released, and also through Nasdaq Online with a one-year history and peer comparisons.

Short position data currently provides the public with two data points per month, aggregated across all short sellers. There is no information regarding the shareholder’s identity, or their motivation for shorting the stock. It is also impossible to discern if it is one large short seller, or multiple small short sellers. A one million share aggregate short position could theoretically be 1,000 accounts each with 1,000 shares sold short, or one account with one million shares sold short.

Daily Short Volume Data

Short volume data is published daily by all exchanges and FINRA for off-exchange short volume. Short volume data is much different than short position data.

First, daily short volume is heavily influenced by market making activity. The role of a market maker is to execute orders for end customers, including short sale orders. In doing so, market makers provide liquidity to customers, but do not take long-term positions. Market makers execute customer short sale orders or take short positions to accommodate buyers, but do not form or publish opinions on individual stocks. They are there to bridge the short term imbalance in supply and demand by taking the opposite side of an incoming trades. They therefore mostly hold a long or short position for very brief (intraday) timeframes.

Second, daily short volume is not netted out against intraday buying, so it’s only one side of the equation. If a market maker shorts 100 shares of a stock ten times in a day and buys them back ten times, short volume is recorded as 1,000 shares even though there is no net change to the short position. The short volume data tells us nothing about sentiment, new shorting or anything else. In fact, high short volume can indicate buyers coming to market makers for stock they don’t hold in inventory. Unless you can see the net change in short position with “buy to cover” indicators, there is no way to calculate the impact on the twice-monthly short position data.

As FINRA points out on its website, “investors… may occasionally perceive the percentage of short sale volume to be unusually high or inconsistent with reported short interest data. This perception may cause market participants to draw inaccurate conclusions about the level or nature of short selling activity in the relevant security.” FINRA goes on to state that short volume data “does not—and is not intended to—equate to short interest position information.”

What can you infer from short position data?

With only an aggregate twice-monthly number, it’s difficult to see details about the many factors influencing a short position. Index membership, convertible securities, liquidity, sector, hedging and stock price levels are factors that affect short selling. For example, in 2023, most companies added to a Russell index saw a meaningful increase in short interest, and a decline in short interest if removed. Nasdaq has observed this for S&P index changes as well.

Based on Nasdaq data, in 2023, 264 of 270 Russell 2000 Index Reconstitution additions (98%) had short position increases with 159 of 166 Russell 2000 removals (96%) seeing a decline. The short position changes are often quite meaningful. Just under half (134/270) of the Russell 2000 additions had short positions more than double, some with much more. For removals, 64 of 166 (39%) saw short positions decline by at least half, with ten dropping 80% or more.

These numbers are consistent each year, indicating index membership influences short position. Reasons include hedging by funds against index positions either in the cash, options or futures markets and more “interest” in these stocks by index tracking funds and active managers. For example Russell 2000 additions value the 9% of float in new passive money and greater active manager trading volume, especially since the incremental short position increase is not a “bet” against company strategy.

In addition to index membership, sector can also have an impact. Biotech companies for example, tend to have higher short positions than similarly sized companies in other industries, presumably due to the higher risk profile. Certain sectors can also be in or out of favor based on macroeconomic events.

Hedging of options and futures positions can affect short position too. Options market makers need to maintain long or short holdings in stocks as hedges against options positions for the life of these positions.

A hedge fund might have a long position in a company because it’s able to be short a peer company or index ETF.

Company-specific factors do play a role. If short positions are increasing, it might mean negative sentiment about the company is building. Since there are only two main data points per month on short position, companies often want to see more.

Since short volume is reported daily, it’s tempting to try and use daily short volume data to make inferences about changes in short position. There are even firms that try to sell services to companies using this data. However, for the reasons noted above, short volume data cannot be used in this way.

What are the regulations around short selling?

SEC Regulation SHO (Reg SHO) has been in place since 2005 and was updated after the 2007-8 financial crisis. The rules apply to stocks on all U.S. exchanges and govern the activities of brokers in conducting short sales, including those around marking an order short, having reasonable grounds to believe a security can be delivered by settlement, and conducting “buy-ins” if necessary. If there are “failures to deliver,” brokers are required to close them out by buying or borrowing the security.

“Fails” occur for many reasons, occurring from both long and short sales. Reg SHO requires exchanges to publish daily a “Reg SHO Threshold Security List,”. This list contains stocks for which a “failures to deliver” of at least 10,000 shares or ½% of shares outstanding has persisted for five consecutive settlement days. Once a company is on this list, tighter rules around new short sales and “buy-ins” apply.

The SEC, on its website, points out that “fails” are not necessarily due to improper “naked” short sales”. The SEC publishes “fails” data twice per month, with a half-month lag. If you ever download the files, you’ll almost always see at least 50,000 rows of data indicating that most companies have some level of “fails” that change each day. Common reasons include mismatches on share count, price, commission, allocation or prime brokerage used.

Reg SHO also created an “Alternative Uptick Rule”, which states that once a stock is down by 10% intraday from its prior close, short selling is restricted for that session and the entire next session. Short selling can still occur, but short sellers can no longer “hit the bid.” The short sale must occur at a price above the bid, which limits the ability of short sellers to drive a price downward. Note the 10% decline can be for any reason, not just due to short selling, so an earnings miss and subsequent 10% decline would trigger a limitation on short selling.

In October 2023, the SEC finalized Rule 13f-2, requiring institutional investment managers that have a short position of at least $10 million or 2.5% of outstanding shares to report short selling data to the SEC. The SEC will compile this data, aggregate and anonymize it, and share the gross, end-of-month large short positions. The SEC will also publish the net aggregated daily activity data for each settlement day.

We are currently reviewing the implications of this new short selling disclosure rule and intend to host two educational webinars on short selling in the first quarter of 2024.

Conclusion

Short selling gets considerable attention. Nasdaq has consistently advocated for more disclosures around short selling, including in a public comment letter to the SEC in May 2022. We continue to believe there should be additional disclosure requirements for market participants who publish, finance, or commission negative research about companies in which they hold short positions.

Still, short selling is a legal investment strategy. Studies show it results in a more liquid market, with more efficient pricing, less volatility, increased capital for long positions, and greater opportunity to ferret out mispriced securities.

The World Federation of Exchanges states that the ability to short sell contributes to “effective price formation, enhancing liquidity and enabling risk management” and “banning short-selling interferes with price formation, thereby increasing uncertainty. That can only artificially amplify volatility and probability of default, the opposite effect to that claimed, and hampers the ability of markets to serve the real economy. It is not – and never has been – true that bans have any other, positive effect on market activity or price levels.”

Nasdaq seeks to partner with its companies and protect investors by creating fair and orderly markets, continually surveilling for market manipulation and advocating for additional short selling disclosure where warranted.

If you have any questions about short selling or the trading in your stock, please contact the Nasdaq Market Intelligence Desk.

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