Short selling is as old as the stock market. “Shorting” is the process of borrowing a security, selling it immediately, and then buying it back at a later date―preferably at a lower price. If done correctly, shorting is way to profit from a decline in the price of a stock.

Of course, a short position doesn't always work out according to plan. If a stock you shorted increases in price instead, you'll have to buy it back at a higher price than you sold it at, resulting in losses. Theoretically, there's no limit to how big those losses can be, because there's no limit to how high a stock's price can climb.

That's in contrast to a stock bought normally, where "zero" is the limit on the downside.

Risky Trading Strategy

Given the nature of short selling, which requires a margin account and consistent monitoring of the position, it's typically only done by active traders with a high risk tolerance. Still, it's a popular method of betting against a security, whether it be a stock or even an ETF.

Indeed, short selling is often done in the exchange-traded fun world, where traders have placed tens of billions of dollars worth of short sales on various ETFs.

Sometimes these short positions are hedges or part of a pair trade made by sophisticated investors. But in many cases, they are outright bearish bets against an ETF in expectation that prices will decline.

Short Interest Percentage

Just as with stocks, certain ETFs are more widely shorted than others. For example, the world's largest ETF, the SPDR S&P 500 ETF (SPY), is a popular vehicle for active traders. Thus, it's unsurprising to see it has a pretty decent amount of short interest, equal to 16% of its shares outstanding.

Compare that to the iShares Core S&P 500 ETF (IVV) or the Vanguard S&P 500 ETF (VOO), two ETFs targeting the same S&P 500 index, but that tend to be held by long-term investors. Short interest in those funds is equal to less than 1% of their shares outstanding.

When short interest is high, it signals that traders are expecting a fall in the price of an ETF. SPY's short interest probably doesn't indicate much, because it's such a widely traded ETF that's used for all manner of purposes, but in other cases, high short interest could tell us more.

Most Shorted ETF

Take the SPDR S&P Retail ETF (XRT). Its short interest is equal to a whopping 508% of its shares outstanding. In other words, nearly 20 million shares of XRT are short, but only 4 million shares are outstanding (it's possible to have a short interest greater than 100% because shares can be continually borrowed and shorted, indefinitely).