The Crucial Piece of Information That Big Traders Get Before Everyone ElseSam Mamudi and Saijel Kishan
In today’s U.S. stock market, trading is fast approaching the speed of light. Yet for one crucial piece of information, many investors still have to wait as long as two weeks for updates.
“Short interest,” Wall Street speak for how heavily a company’s stock is being targeted by traders betting prices will fall, is arguably the best predictor of returns, research suggests. But the official tallies from exchanges are almost always outdated, a substantial handicap when speed is paramount.
So important is the short-selling information that the big hedge funds get up-to-date estimates from their brokers or pay for it themselves. For everyone else, getting market-moving data well after the fact is akin to flying blind. And that can be disastrous when you’re on the wrong side of a trade.
“If you’re invested in a heavily-shorted name, the volatility of trading is such that the two-week-old data is irrelevant,” said David Tawil, the founder of Maglan Capital, a $75 million hedge fund in New York.
To a growing number of investors, it’s another example of how regulation has failed to keep up with the changing structure of the $25 trillion U.S. stock market, where powerful computers and access to privileged information are calling attention to the gulf between the haves and have-nots.
It also reinforces the notion the stock market has become increasingly skewed at the expense of smaller investors.
Finra, which oversees the official count as Wall Street’s self-regulator and compiles the data from as many as 150 firms, says faster updates would lead to mistakes.
“Analysis conducted in the five days before the data is published is a critical component for maintaining the integrity of this important data,” spokesman George Smaragdis said.
Trading in Lumber Liquidators Holdings Inc., embroiled in a controversy over formaldehyde in its flooring, suggests the time lag may have cost some unsuspecting investors.
While data from subscription services detected a surge in short interest to record levels in late January, the official tally didn’t show that uptick for three more weeks. Over that span, Lumber Liquidators rallied more than 15 percent, ending at a seven-month high of $69.22 on Feb. 23.
That was just before the bottom fell out.
On March 1, “60 Minutes” aired an expose alleging that Lumber Liquidators sold toxic flooring and featured an interview with hedge-fund manager Whitney Tilson, who began shorting the stock in October. The allegations -- which Lumber Liquidators denied -- accelerated a swoon that lopped off more than half the company’s market value within days.
Shares of the Toano, Virginia-based company, which halted sales of the Chinese-made flooring last week and is replacing its chief financial officer, ended at $28.14 on Friday.
There’s “an information advantage over the smaller players,” said Donald Steinbrugge, the founder of Agecroft Partners, an investment adviser in Richmond, Virginia.
For short-selling data, the edge can be significant. In an academic paper in February, David Rapach of St. Louis University and Matthew Ringgenberg and Goufu Zhou at Washington University in St. Louis found that the higher the level of short interest, the more likely a stock will fall.
Short sellers are better at predicting performance than investors who solely focus on rising markets because of the difficulty, risk and expense of making bearish bets, they said.
Timely short-selling information is available for some. Banks including Credit Suisse Group AG and JPMorgan Chase & Co. send daily or weekly reports to hedge-fund clients on short selling in certain stocks and industries, the amount of shares bought to close a position and those that are costly to borrow.
Investors who don’t have close relationships with the big banks and are willing to pay can turn to providers including Markit Ltd. and SunGard Data Systems Inc.
These firms collect data from mutual funds, hedge funds, custodians and brokers, asking how many shares they have lent and borrowed. The information is distributed through companies including Bloomberg LP, the parent of this news organization.
In Europe, next-day disclosure requirements on short selling, implemented in 2012, bolstered trading and reduced the gap between bid and offer prices, according to Charles Jones, a finance professor at Columbia Business School in New York.
U.S. authorities, who shortened the reporting standard from once a month in 2007, have recently looked into releasing the information more rapidly. In June, a Securities and Exchange Commission study said collecting real-time data may discourage abusive short selling, but it could also aid copycat and front-running strategies that hamper trading.
While the SEC concluded the benefits of real-time disclosure was limited, Ringgenberg says there’s little evidence to suggest the current schedule is the best one.
“What I’d love to do is get the SEC or someone to let us run an experiment and really see which is the optimal policy,” he said.
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