Short ratios at work: Netflix in 2017-18
Let's take a look at a classic example of short ratios sending useful signals to watchful investors. The stock under my lens is media-streaming pioneer Netflix (NFLX +1.15%), and I'm turning the clock back to the 2017-18 span.
Netflix was on a roll at the start of this period. The stock had gained 1,150% in the first five years of the digital streaming business. The all-digital business plan won over many skeptics. The number of shares on loan to short-sellers had dropped from 64 million to 24 million. However, the hot growth stock had cooled down recently. Netflix's stock only rose by 8% in 2016. As a result, trading volumes dropped dramatically, and the short ratio rose to a multiyear high of almost four days.
At this point, the stock was poised for dramatic volatility. It wasn't the number of short-seller bets that made the stock prone to sudden price swings but a decline in trading volume. Either way, the short ratio was on the rise.
Sure enough, Netflix's stock chart turned volatile over the next two years. There could have been a bearish move, but the actual bull run that followed also made sense. Trading volume doubled, Netflix's stock price rose by 116%, and the short interest fell to all-time lows. By the end of 2018, the market could cover all of Netflix's short sales with the average trading volume in 1.1 market days. The overheated short ratio had cooled down.
The actual market moves were based on Netflix's fantastic subscriber growth in those years, of course. Above all else, the company released blockbuster shows such as Stranger Things, Money Heist, and Narcos during the two years. These hits were never meant to manipulate any specific stock market metric, and certainly not the short ratio, but they sure boosted Netflix's trading volume and lowered the skeptics' short-selling investments. A lower short ratio simply followed from these business-driven trends.
This metric is a measuring stick, not a steering rod. But when the short ratio soared, a volatile period looked likely to follow. Netflix delivered on that promise.
