Shorting Penny Stocks Strategy: Risks and Benefits

Shorting Penny Stocks

Most manuals on how to trade penny stocks online teach you how to find awesome penny stocks that are booming and start making money right off the bat. However, when purchasing selections from hot penny stocks lists, chances are they are already overpriced to begin with. Shorting penny stocks strategy focuses on a contrary market trend of finding companies that are overvalued and purchase put options against them. When purchasing put options, a short seller has an option to sell stocks at a certain price on a set date. If penny stock prices fall, the investor makes money from shorting penny stocks. If the prices rise, the opposite effect takes place.

There are definite penny stock risks when it comes to shorting them. Trading penny stocks is risky enough alone, with shorting penny stocks another dimension of risk management must take place. Some of the risks investors face is inability to find buyers for the short sale option or finding a stock that actually keeps going up in price instead.

Another strategy of shorting penny stocks is finding a broker who will allow you to borrow stocks from him and sell them at a profit. In order to make a profit, it is important to find penny stocks that you believe will decline in price, these are mostly stocks of companies that are currently overpriced. So again shorting penny stocks is defined as selling securities you do not personally own. Once you know which stocks you want, finding a broker who will lend you certain stocks is the next step. Not all brokers will allow you to do this because most of them do not have the tools to carry out the mechanism. The next step is to sell the penny stocks and wait for them to start declining in price. Once this happens – bingo! You just made a profit on shorting penny stocks. Now it is time to re-purchase the same set of stocks but for a much lower price and return them to the broker.

This is not the strategy all penny stock traders understand or are willing to participate in because of the obvious inherent risk of losing a lot of money at once. However, if you are good at watching stock trends and reading through financials and company’s descriptions, with time you will be able to identify penny stocks that are overpriced and headed for the dump. In fact, some investors specifically bet on against notorious “pump and dump” schemes and consider them their specialty.

Short sellers of penny stocks actually bring benefits not only themselves but to the market as a whole by increasing liquidity of certain stocks and helping balance out the prices. They help maintain equilibrium at the market by betting on the opposite trends than everyone else.

Books similar to Penny Stocks for Dummies warn new investors against participating in similar investment mechanisms due to very high risks involved. Lack of information that any penny stock is associated with multiplied by lacking abilities to analyze market price trends and ever-changing penny stock climate can entail massive losses that could be hard to contain. While the benefits of shorting micro caps might seem alluring, it is better to stick with good old buying and holding stock scenario for newbie investors.

More on shorting penny stocks can be found here.