When many traders are betting against a stock, it could be time to buy, Morgan Stanley says

Traders wear masks as they work on the floor of the New York Stock Exchange as the outbreak of the coronavirus disease (COVID-19) continues New York, May 27, 2020.
Lucas Jackson | Reuters

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When enough people on Wall Street are betting against a stock, it might be time to buy in, according to new research from Morgan Stanley. 

Strategists from the bank's quantitative equity research team examined short interest, which generally measures the cumulative size of the bets that the stock will go down relative to the total number of shares. Typically, mirroring the market's short interest — buying the stocks that others like, and betting against the ones they dislike — generates extra return, the researchers found.

However, when short interest gets to an extremely high level, the best strategy changes, and Morgan Stanley identified some major stocks where the short trade has become crowded.

"We find that our signal often acts as a contrarian indicator when it reaches extreme levels," the note said.