The short ratio (or short interest ratio) is usually the number of shares outstanding of a publicly traded company that is sold short, divided by the average daily trading volume (daily transaction). It can also be the percentage of the free float that is "shorted".
It is one measure of the market's outlook on a given stock; a higher short interest ratio indicates more pessimism, because a higher proportion of a company's total float has already been sold short.
The short interest and short ratio can be deceiving, however, when a company has many convertible securities outstanding and is perceived to be at risk, because convertible and options arbitrageurs will often sell the stock short to manage risk with their long positions in these other instruments.
Technicans (Technical Analysts) interpret this ratio contrary to one's initial intuition. Because short sales reflect investors' expectations that stock prices will decline, one would typically expect an increase in the short-interest ratio to be bearish. On the contrary, technicans consider a high short-interest ratio bullish because it indicates potential demand for the stock by those who previously sold short and have not covered the short sale.
A technician would be bullish when the short interest ratio approached 5.0 and bearish if it declined toward 3.0.
Convertible hedgers are usually not hoping the price of shares will fall and, if properly hedged, can cover their short positions with shares embedded in the convertible securities. Thus, a large short interest position for such companies does not necessarily imply a classic short squeeze, and the short interest ratio becomes somewhat meaningless.