Can You Short Sell Penny Stocks?
Contrary to what some traders believe, yes you are allowed to short sell penny stocks. This tends to surprise and confuse people mainly because investopedia.com have stated in the past it was illegal, obviously this has been proven incorrect by Tim Sykes. Learning how shorting works makes you a more diverse and flexible trader because you can make money in any market environment like Investors Underground. So this gives a person the unique ability to make profits on the way up or on the way down. Statistically the odds should be in your favor since every pump and dump will inevitably drop 95%, following the promotion. The hardest part is waiting for the price to collapse and locating shares before this crash happens.
There are a number of factors that should be taken into consideration while using this strategy:
1. Allocating Shares is Becoming Increasingly Difficult
Trying to locate shares can be really difficult and time consuming. The margin rate is very high when you try to hold these stocks in the long term. You will need to open multiple brokerage accounts in order to find the best borrows. There is no single broker that will allow you to short every company. If you setup accounts with the top 4 brokers this will allow you to short roughly 80% of your plays. But remember each broker has different account minimums so this strategy is not ideal for people with small account sizes and don’t forget the PDT rule will come into effect. Some of the best brokerages for short selling penny stocks are Interactive Brokers, Speedtrader, Etrade and Suretrader. Brokers dislike dealing with people who trade small caps because they are risky and they can’t make worthwhile commissions from small accounts.
2. A Margin Trading Account is Needed
In order to leverage this strategy you have to trade with margin, on the other hand it is not required when buying shares. Whether you like it or not, you’re borrowing money from your brokerage. Many traders don’t feel comfortable borrowing from their broker. Also more capital is needed to open a margin account than a cash account. You are required to put up 50% of the total position size that you want to short sell, as collateral. This is known as initial margin. If the stock increases then your margin levels will fall. When your margin levels fall below 30% your broker will have no choice but to issue a margin call. This forces you to deposit more money into your account until your margin level is brought back up to at least 50%. If you don’t do this your position will be liquidated immediately. Penny shares can spike 50-100% rapidly due to unforeseen circumstances like a promoter sending out email alerts at random times throughout the day. You end up losing money purely because your timing was off.
3. Short Squeezes
When you short shares you are borrowing shares from someone who owns position in that company. The original owner of the penny stock may ask for their shares back at anytime. This is can cause what is known as a ”buy in” and can usually happen after a few days up to 2 weeks. A broker may issue a ”buy in” if you’re in a massive losing position automatically without warning. Essentially you have little or no control of what happens, causing you to lose on that trade as the broker will buy back the shares at current market price. “Buy ins” can cause short squeezes to increase the share price artificially as traders are being forced to cover there shares at around the same price levels. CYNK is an example of a crazy short squeeze in action. Back in 2014 CYNK Technology Corp, a worthless “social media” company surged from 0.06 to $22 (36,000% gain) before finally being halted by the SEC. At one point this one man run business had an insane valuation of $6 billion when in reality it was worth $20. In hindsight the accident was caused by a hedge fund trader.
4. The Market Can Remain Irrational Longer Can You Can Stay Liquid
In contrast to what old school economists think, the markets can be very irrational. A lot of investors predicted the housing and dotcom bubble but went broke shorting because the bubble continued to inflate higher until they were forced to cover their positions. These same investors had sleepless nights after the bubble burst, they made the right trade but at the wrong time and stubbornly wouldn’t cut their losses. Another example happened recently with DryShips Inc (DRYS), after Trump got elected the shipping sector was red hot. Within the space of 6 days DRYS exploded from $5 to $72. I’ve heard stories of a trader on Stocktwits losing well over $200,000. He shorted DRYS when it was at $20, he held onto his position and watched on in disgust as the price continued to rise. It was a freak event and now DryShips Inc is trading at $4.10. Patience and the ability to cut your losses are crucial to being successful. Only get involved in situations where the risk is worth the reward and avoid companies below $2.
Short selling penny stocks is a clever strategy but there are various problems to overcome. I don’t recommending shorting shares under $2 purely because the risk to reward isn’t favorable, it’s like picking up pennies up front of a steam roller. It’s common for new day traders to make a couple hundred dollars on a hand full of trades and then blow up on just one trade. The PDT rule is another obstacle to get around. Unless you have $25,000, you’ll have to use Suretrader and they don’t have a great reputation. Also multiple stock brokers are required, potential short squeezes and increasing competition as more people are trading micro caps, so finding shares to borrow will become more difficult. Traders like Timothy Sykes, Tim Grittani, Nate Michaud and Michael Goode are all out-liars and have compiled their profits in millions through thousands of small gains along the way. If you’re interested in learning about this method check out the videos on YouTube and Timothy Sykes website for more detailed information.