What is shorting?
In simple terms, short selling is a process by which your broker lends you stock. You sell the stock, and you keep the proceeds from this sale. However, at some point you must buy back the stock you sold and return it to the broker. When you buy back the stock, it could be at a lower price, meaning you keep the difference. If it is at a higher price, you lose money. (read more)
The blow-by-blow guide to ‘short selling penny stocks‘
If you want to enter into the world of short selling stock, you must understand that it can get aggressive. However, when you have properly thought about the risks versus the rewards and bought stock it can give you big returns. You need to know what to do in order to get good stock. The ideal stock is one that would reduce in price after you have sold it. This is because you can then buy it back at a lower price. This means you make a profit.
If you think you are ready to be a part of this game, you should be prepared. You should also have a good idea of exactly what you are doing. If you need to brush up on your short selling know-how, or you are new to the game, check out these steps. Follow them, and you should be able to get some good returns.
- Acquire Target Stock
As aggressive as that sounds, it is what your first line of business should be. Look at the current market and find out which stocks you feel will go down in price over the next few days. This is the stock you need to buy to make a good return. You need to be okay with the fact that you can’t always win. It is a guarantee that at some point, you will make a mistake. Accept this and move on.
- Borrow your target stock
After having identified the stock you would like, find a broker who has shares in that company to short. This means they have extra shares that they aren’t currently trading, so they can lend it to you for a while. Always have a list of the brokers who lend shares to short. They aren’t many, but they can make the difference between breaking out or not.
Ask the broker to lend you the amount of shares of that company (ies) that you want to short. This means you will owe the broker that amount of shares, but not that value.
Sell the stock you borrow immediately. The money you obtain from this is yours.
- Wait for it…
Wait patiently for the stock price to go down. If you took the right risk, it should go down in the near future, which is when you know it is time to strike.
This doesn’t have to mean that you left it to chance. Look at the financial statements of the company in question as well as their stock price patterns in the past. This should allow you to forecast it more or less accurately.
- Buy back the stock
Once the price has gone down, buy back the same amount of shares that you sold! For example, if you spent $4000 on 1000 shares, and the price goes down to half the original share price, you can buy 1000 shares back for $2000. This means you have made a $2000 profit off the short.
On the other hand if the share price were to rise, you would be at a loss. The profit is the difference between how much you sold the original stock for and how much you bought it back for.
- Return the stock
Remember, you do not own the stock you bought back. Return the shares to the original owner (the broker) and wait for a similar opportunity to arise again.
There you have it, the basic procedure of shorting. With the right research and calculated moves you should be able to make a profit using this method, but don’t think for a second that you are invincible. No one is untouchable.
The Risks and Disadvantages of Short Selling
While the process may seem relatively easy to do, and looks like it will guarantee a high return 90% of the time, there are a few disadvantages of short selling penny stocks.
- Finding stock to short is difficult
The process of identifying stock that you want to short sell is actually very time consuming. It is no easy task to find the stock that looks like it will crash, before it actually does. Since penny stocks are so volatile, this could happen at any time. In addition to this, not all brokers have stocks to short from all companies. Accounts will have to be opened with a lot of different brokers. Monitoring all of these can cause severe migraine.
- You have to use a margin account
To short sell microcap stocks, margin accounts will have to be used. These are usually quite undesirable to traders. Margin accounts mean you borrow money from your broker. You must deposit enough money into the account to keep the margin at 50% of the value of the stock you want to sell.
Once you sell the stock, if the price should rise, the margin level will fall. If it falls to 30%, your broker will make you deposit even more money to raise the margin again. This an be a very stressful experience so traders prefer not to.
- Beware of short squeezes!
A short squeeze happens when the person whose shares you are short selling asks for them back. Your broker will have to buy the shares back from you at the current market price. If the price has reduced, you will have to cover the extra cost out of your own pocket. This is extremely undesirable.
While short selling can be tempting to do, it is not effective as a long term method. Short selling could be something you try when you’re bored and you want to spice up your life. It could be something infrequent. Just make sure you don’t get carried away with it.
Have fun, short stuff.