Penny Stocks: Shorting?

Several of you have privately emailed us wondering where you can go short on penny stocks.

Before talking about this, let’s provide a quick description of what “shorting” is for those who may have no idea what we are talking about.

Shorting is the act of selling a stock that you don’t own with the hope the stock sold goes down in price and with the intent of later buying it cheaper to cover what you sold to begin with. Hmmmm. Confusing? And how do you sell something you don’t own in the first place?

There are two ways to short a stock in the market. The typical way, and the only method available to most of us, is to find a stock you think will go down in price, convince someone who owns that stock to lend you shares, sell those shares, and at a later date buy the shares back in the market and return the stock to the original owner. The second way to go short is “naked shorting,” a maneuver mostly limited to market makers and of questionable legality, and one we won’t discuss here.

So, let’s say you think stock MILV is heading down and you want to take advantage of your hunch. Via your broker’s trading system you ask whether they can find MILV shares to borrow. If the broker can, and allows you to short (there are margin requirements involved), you will be able to enter a sell order for the stock they have found for you to borrow, put the cash in your account from the sale, and then have an IOU with the brokerage to at some point cover the stock sold so it can be returned. If the share price of MILV goes down you make money because you have already sold the stock at a higher, earlier price. However, if the share price goes up you lose money, because now you have to buy MILV back in the market at a higher price than what you paid in order to cover your short position. In many ways, “going short” is the opposite of “going long,” which of course is buying a stock hoping it goes up.

Because of their volatility, many people are interested in shorting penny stocks and some interesting scenarios arise where traders can profit from going short, particularly during the more aggressive pump and dumps.

There is a barrier to shorting penny stocks though and that is that most brokerage firms do not provide the ability to short penny stocks, period. But some do. We generally try to keep the information on which brokerages do allow shorting on a proprietary basis because it is valuable, but we’re happy to share two firms that do allow shorting: Interactive Brokers and Broad Street Trading.

Because we prefer going long on most situations, and because shorting penny stocks is somewhat more involved and complicated than normal penny stock trading, we leave it up to the individual investor to reach out to IB and Broad Street Trading for further information.

But if you have the resources and the time to follow different situations, and an appetite for risk, there is certainly money to be made going short on penny stocks. Again, our preference is to buy penny stocks to go long.

Jeff Mirkin
Admin

http://www.damngoodpennypicks.com