I think this is what Phil was referring to on his radio program about specialists and how it is a systemic problem - he said recently about 20 specialists got arrested for using thier insider information but that this was just to appease some people - the system still needs to be changed to be fair - he said these people that get chosen as "floor specialists" is like a mafia family business:
moneycentral.msn.com
The crucial data Wall Street's slow to share
The number of people making bets against a stock is a big clue to whether it's going up or down. But the exchanges aren't in any hurry to report the information.
By Michael Brush
Wall Street is trying hard to clean up its image and restore confidence in the stock market, but on one count, at least, it still falls short -- giving a handful of privileged insiders an edge over the little guy.
This inequity stems from foot-dragging by the stock exchanges and brokerage houses in revealing crucial numbers on how many people are betting against stocks by taking short positions.
Short selling is when investors bet against stocks by borrowing shares and selling them, with the hope of replacing them later at a cheaper price.
The number of people betting against a stock can provide big insight about whether that stock is about to go up or down. Yet in this age of advanced technology, when all sorts of arcane market data are zapped around the world instantaneously, the stock exchanges are stuck back in the days of the pony express when it comes to reporting the level of short interest.
They tell us the short interest in a stock at the embarrassingly slow pace of once a month.
Why short interest matters
To understand how this hurts the investor, it helps to know what analysts think they can divine from knowing how many people are short a stock.
First, many of them view short sellers as the “smart money.” That’s because short sellers typically work at hedge funds, which often do more legwork to dig up company dirt that hasn't yet been unearthed for the public to see.
“Short interest is an interesting number because it gives you an indication of, quite frankly, what the smart money is doing,” said Ken Morris, a former trader at Morgan Stanley who founded that brokerage firm’s international trading desk. “Many short sellers do more research than anyone, and they also get information in all kinds of ways, some legitimate, some not so legitimate.”
A second camp takes a more contrarian view of short interest. These folks prefer to bet against shorts by going long stocks with large short positions -- especially when those stocks are in an upward trend.
The theory here is simple. If lots of people are short a stock that’s moving up, they’re feeling pain, and at some point they may panic and try to buy back their shares all at once to “cover” their short positions. Known as a “short squeeze,” this dynamic can provide a nice pop in the price of a stock.
“The heavier the short interest, the more powerful the rally can be,” said Ralph Acampora, a technical analyst at Prudential Securities.
Some real-life examples
Let's look at just how investors are hurt when New York Stock Exchange and Nasdaq regulators drag their feet in releasing short-interest numbers. To do that, we'll walk through an example with Phil Erlanger, of ErlangerSqueezePlay. He’s a technical analyst who uses the level of short interest to develop weekly stock picks of potential short-squeeze candidates. This list has outperformed the S&P 500 by an impressive 70% since March 2002.
On April 14, Erlanger suggested clients go long Juniper Networks (JNPR, news, msgs) at around $9 because the company issued positive earnings guidance that he believed could pressure shorts to cover; the stock had had the biggest short-interest ratio he’d seen on it for years. A short-interest ratio, in Erlanger’s system, is the number of shares sold short compared to the average daily volume in the stock over the previous 12 months. Bigger ratios mean more people are short relative to the typical volume. This situation tends to increase the chance that the stock will jump sharply because more shorts are around to cover when price moves go against them.
Since early April, Juniper shares have advanced to about $13 from $9. Meanwhile, that big short-interest ratio for Juniper was confirmed in an April 25 monthly report by the National Association of Securities Dealers (NASD) -- which regulates Nasdaq. (To underscore how slowly the exchanges report, that April 25 release was based on numbers compiled as of April 10.)
Now, near the end of May, a whole month has gone by and Erlanger still can’t tell whether Juniper’s strength since April 25 was due to short covering or not -- even though that information would help investors decide whether to take profits.
“Here it is the end of May, and I haven’t had a fresh read on the short selling, and a lot has happened,” said Erlanger. “I need to know if the shorts gave up the ghost or if more shorts came in as the stock went higher.” If the short interest went down because shorts covered, Erlanger would be more inclined to take profits, because it means there’s less potential demand remaining from short covering to drive the stock up even more.
Unfortunately, Erlanger and his clients had to wait until today, May 28, to act on the most recent short-interest data in Nasdaq stocks like Juniper; the information came out yesterday, May 27, after the close. “So I am really at risk here not knowing. It’s what you don’t know that will hurt you. It would be much more helpful for me to have the short interest data on a daily basis.”
Erlanger is hardly alone in his advocacy of more information flow. Says Acampora, "I think we should be privy to that information on a more timely basis."
Erlanger and others say the short-interest information would better inform broader market calls, as well. For instance, several indicators now point to excessive bullishness in the market -- a sign that it may be time to sell stocks and move into cash because too many people have bought in to the rally. Yet once again, an important sentiment indicator is missing because the stock exchanges report short interest only on a monthly basis.
“The key to whether the market can move meaningfully higher is whether people shorted into this up move,” said Erlanger. “If they did, then that will give fuel to this advance. If the shorts capitulated, which is my suspicion, then we will get more down days ahead.”
By the way, some other good short-squeeze candidates -- again, stocks with potential upside because investors continued to add to short positions as the stocks advanced -- are Rowan Cos. (RDC, news, msgs), Stanley Works (SWK, news, msgs) and Continental Airlines (CAL, news, msgs) on the NYSE. Those picks are based on pretty recent monthly NYSE data released May 21. Nasdaq short-squeeze candidates include Apple Computer (AAPL, news, msgs), Check Point Software Technologies (CHKP, news, msgs) and eBay (EBAY, news, msgs). These picks are based on nearly month-old NASD data that will be updated today, May 28.
Determining whether a short-interest ratio is big requires a little math and some good databases. First, you have to divide the short interest by the average daily volume. Erlanger uses a 12-month average daily volume. This gives you the "days-to-cover" ratio -- or the number of days of average volume it would take all shorts to cover. Then you have to compare that days-to-cover ratio to the historic range for the stock to determine whether it's at the high end. A days-to-cover ratio of 3.64 for Juniper is high for that stock. But for other stocks, it would be low. Among the Web sites that offer screens of stocks with extreme short-interest ratios is ViWes. (See the link for it and other short-interest data sites at left under Related Sites.)
Why the painful delay?
If the short-interest numbers are so important, why do they only come out once a month? “Historically it was just a big pain to collect the data,” said James Angel, an expert on stock markets who teaches finance at Georgetown University's McDonough School of Business. “So it was only done on a monthly basis.”
But what about now in the age of advanced information technology?
Officially, the NSYE and NASD say they still report short-interest numbers once a month in part because they simply haven’t gotten requests from the public or their member firms -- the brokerage houses -- to report the numbers more frequently. If they really wanted to provide transparent markets, however, you’d think they might take a little initiative. “If the exchanges are interested in people becoming more confident in the market, that’s quality information that would go toward building confidence,” said Erlanger.
Second, the exchanges say it’s still hard for the brokerages to compile the numbers daily and check them for errors. But at a time when giant clusters of complex software are used to report and slice and dice market data a thousand different ways every second, this excuse rings hollow. "It may be a bit of a chore, but, in this day and age, you can’t tell me that it can’t be automated,” Erlanger said.
“They could wire their computers to do a sweep at the end of the day,” agrees Prudential’s Acampora. “I can’t image it would be too difficult.” At the very least, the exchanges could release the total volume of short selling on a daily basis, said Georgetown University's Angel.
Meanwhile, traders and market commentators point to other possible reasons for the delay. For one thing, the exchanges might not be so sure they can make enough money selling the data to make it worthwhile to dig it up faster.
More cynical explanations bubble to the surface, as well. Market insiders, for example, no doubt enjoy the fact that they are privy to information about short selling before everyone else. Who are these insiders? Two types, in particular, are worth noting: floor "specialists" and Wall Street brokerages.
The NYSE assigns specialists to each stock and charges them with keeping an “orderly” market in the listing. Specialists are in a unique position to see supply and demand for a stock, as they keep a book of buy and sell orders throughout the day. They’re supposed to take positions in stocks to help prevent wild price swings, and they can also trade for their own profit.
There’s little public information on what specialists earn doing this. But, says former Securities and Exchange Commission Chairman Arthur Levitt in his book, "Take on the Street," initial public offering documents for the 1999 listing of the specialist firm LaBranche (LAB, news, msgs) indicated specialists earned $1.7 million annually. He also likened the advantage of the specialist to “being in a card game in which only one of the player gets to see everyone else’s hand. Specialists exploit that advantage, too.”
In any event, specialists on the floor of the NYSE can easily track the level of short selling on a minute-by-minute basis because all sell orders get tagged as short sales or sales out of long positions. To be sure, watching short sales doesn't always tell specialists much about outright short interest. That's because the short sales they see in the morning may get covered by the afternoon -- and the specialists probably wouldn’t know.
“But it is still an advantage, and one would think they make use it,” said Morris. “It seems unfair. But it’s in their self-interest not to change a system in which the specialists make an obscene amount of profits in all markets, up, down and sideways.” The NYSE points out that strict rules bar specialists from using non-public information for their own benefit.
As for the brokerages, traders -- particularly options traders -- routinely monitor short sales as they sift through transactions looking for clues as to how key "smart money" hedge funds are playing stocks. Granted, these traders don’t see the big picture. But just like the NSYE specialists, they do see large chunks of it.
What’s the big deal?
To many market players, complaints about delays in the reporting of short interest are misplaced. For example, David Rocker, who as a money manager at a well-known New York hedge fund called Rocker Partners is no slouch when it comes to short selling, thinks that the level of short interest tells you nothing about sentiment toward a stock these days.
For one thing, lots of investors have short positions on stocks as a hedge simply because they own convertible debt that can turn into stock if certain trigger events occur. Market-neutral funds use short positions as hedges against long positions in similar stocks in what’s known as “pairs trades.” Shorts are also put on as hedges against long exposure taken on through stock options. “Short interest is irrelevant because two-thirds of short positions are part of an arbitrage,” said Rocker.
Erlanger, however, is skeptical about hedge fund managers who make these arguments. “You're talking about people who don’t want others to know what they are selling short,” said Erlanger. “Most people who use short selling to make money have a bias to not letting other people see what they are doing.” That’s because when the public knows a big short position is out on a stock, it’s easier for longs to try to drive the stock up and set off a short squeeze -- the short player’s nightmare.
Besides, said Erlanger, even if investors have short positions as a simple hedge or arbitrage -- and not because they hate the stock -- those short positions still represent potential demand that could drive the stock higher. Knowing that those people are short is valuable information -- information that would help restore investor confidence in the markets if it were released more than once a month.
“If the exchanges are truly interested in raising confidence in the markets, they should make structural changes that give people more information on which they can make better decisions,” said Erlanger. That would help the exchanges, too, by increasing trading volume. “The more confident people are in the data they look at, the longer they will stay in the game, and that is in everyone’s favor. This is a win-win situation.”
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