NEW YORK (CNN/Money) - Somebody has the market dreadfully wrong. When they realize it, there will be hell to pay.
There are always camps of bullish and bearish investors pushing their beliefs on which way stocks are headed, but rarely have things been so polarized as they are now.
Both the Nasdaq Stock Market and the New York Stock Exchange released short-interest figures earlier this week. On the Nasdaq, the number of shares sold short through Sept. 15 rose by 2 percent from the period ended Aug. 15. This despite an 8 percent rise in the Nasdaq Composite -- the sort of rally that usually sends short seller racing for cover.
On the NYSE, short interest fell by 1.5 percent. But it is still historically high, coming in at around 1.57 percent of total market capitalization according to Rhodes Analytics.
Bullish commentators regularly suggest that this heavy short interest is a powder keg, and that it means the market is set up for a huge rally to the upside.
To bet against a stock by going short, an investor borrows the shares from his broker and sells them, hoping to buy them back later at a lower price and return them. The difference between the price he gets to keep.
But when the shortseller gets it wrong, and the price of the stock goes up, he has to buy back the stock at a higher price. When things get out of hand, he's going to buy in a hurry, which only makes the stock go higher still. Such short squeezes can be powerful.
If there is an opposite to selling short, it is buying on margin -- borrowing money from the broker in order to buy more shares than you can with your cash at hand. And margin debt, too, is rising. At NYSE-member firms in August it rose to $149.66 billion, up 0.8 percent from July and 11.3 percent from the beginning of the year.
Through July, the NASD has reported that Nasdaq margin debt grew to $26 billion, up from $5.1 billion at the start of the year. This prompted to Nasdaq to issue a warning on the dangers of buying on margin. Put simply, if you borrow money to buy stocks, and your stocks go down sharply, your broker, worried about keeping its principal, may issue a margin call: If you can't come up with additional cash, it will liquidate your stocks. It can send stocks down as sharply as short squeezes can send them up.
Both shorting and buying on margin are dangerous business. Investors who practice either really need to know what they're doing. Alas, often they do not. Somebody really is sitting on a powder keg. We just don't know who it is yet.
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