Short Sellers Are Still MIA

The New York Stock Exchange released its biweekly short interest report on Tuesday, and it shows that even though bears are talking the talk, they have yet to really walk the walk. Since the last report two weeks ago, the S&P 500 index has sunk by more than 7%, yet short interest has stayed remarkably steady, increasing by less than 0.5%. The Nasdaq's short interest actually fell by 1.6%.

Unfortunately for bullish investors, this is really not a positive for the market, as short interest tends to serve as a contrarian indicator. Investors need not look back any further than the end of June for an example. Markets were in turmoil, investors were scared, and bearish bets via short interest had risen to their highest levels of the year. So what happened next? You guessed it: The market staged a sharp rally and gained 7% in July.

So what makes this data point a contrarian indicator? There are two schools of thought that often make this scenario play out. First, as bearish bets against the market rise, there comes a point when the shorts are fully committed, and there are few investors left who are looking to short. When this happens, a quick rise in the markets can lead to what's known as a short squeeze, in which the short sellers look to cover their positions in fear of losing profits or incurring greater losses. This squeeze induces a short covering rally in which short interest rapidly declines.

On the other hand, short interest also serves as a buffer against rapid declines in the market. This happens because short covering essentially serves to put a floor under share prices at some point. The takeaway is to be wary of making bearish or bullish bets on stocks with extremely high short interest. There is obviously a reason investors are betting so heavily against these companies, but there's a big chance that you're already late to the shorting party -- and in danger of a serious squeeze. Below is a list of stocks in the S&P 500 that currently have the highest short interest as a percentage of their float. Let the buyer (or short seller) beware.

Source: Capital IQ, a division of Standard & Poor's, and author's calculations.