Short selling penny stocks in theory would seem like an awesome strategy since every single pump and dump eventually implodes and falls back towards $0.0001. Unfortunately, there are some very big reasons why it is not a good strategy for the majority of new traders. When trading penny stocks you have to consider many factors.
Margin is the issue
The problem with short selling penny stocks is that you must trade on the margin whereas buying penny stocks does not require or even allow using margin. When you place trades on margin you have to borrow money from your broker (whether you like it or not). For instance, you typically have to put up 50% of the total position size dollar amount that you want to short sell, as collateral. This is called the initial margin and every broker requires this.
If the stock does not drop immediately as you are hoping it will, and instead continues to rise, then the margin level in your account will drop. If the margin gets below 30% then the broker will issue a margin call which means you will immediately have to deposit more money into your account to bring the margin level back to the initial margin level at 50%. If you don’t do this they will liquidate your position immediately at the current market price and you will automatically lose money if you are down on the trade (potentially thousands of dollars).
Few people have the capital, expertise, or nerves of steel for short selling penny stocks.
Since penny stocks can spike a very large amount in a very short period of time, and they sometimes continue to spike for days or even weeks, this can mean you could lose thousands of dollars this way, even though you know the stock will be back at $.01 or even $.001 in a few months, since all these companies are frauds. When shorting penny stocks you have to be very careful to cut losses quickly.
Borrowing shares is very difficult
The other issues are that it is very difficult to locate shares of these low priced penny stocks to borrow to short sell them and the margin rate is very high, sometimes 40% per anum (basically like borrowing from a bookie) when you try to hold these stocks longer term. Several brokers will allow you to short these stocks, but a majority will not since the risks of short squeezes are so high and since you are essentially borrowing money from your broker (margin) when you short sell, the brokers don’t like taking these sort of risks considering most people are clueless about the penny stock market.
“Buy In’s when short selling penny stocks”
On top of this, since you have to borrow shares of stock from the original owner of the penny stock, they may ask for their shares back at any time. This is called a “buy-in” and it can happen after a few days or usually at most 13-15 days. If the stock is going higher and you are down on your short, and you broker issues a “buy-in” you will immediately lose on the trade since the broker will buy back the shares that you shorted at the current market price (and this could be a large amount). Buy in’s almost always cause penny stocks to rise even more than they already have essentially caused an artificial short squeeze because many people short sell around the same price levels and therefore lots of buy-ins occur at the same time.
The last problem regarding short selling penny stocks is also related to the brokers but basically, there’s no single brokerage firm that will allow you to short sell a majority of low priced penny stocks. There are about several brokers that when combined will let you short sell about 80% of these pumps and dumps, but they each have a minimum initial deposit amount and when combined you need at the absolute minimum $30,000. Most people don’t have this so this sort of trading capital so this is another issue.
Summary
In summary, there are numerous angles to trade penny stocks. Buying the pump, shorting the dump, and buying the bounce are the three strategies I utilize, but short selling is just not feasible for new traders.
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