Even though I entitled this article "How To Make Money Shorting Penny Stocks..." I think it is important for me to state right away that my primary purpose in writing it is to discourage you from the practice of shorting penny stocks. It is an exceedingly risky enterprise and many people end up losing not just their entire investment but actually end up losing more than than they originally planned to invest (more about this below). It has been estimated that more than 99% of all investors who try their hand at shorting penny stocks are no longer doing so a year later. I think this statistic speaks for itself, don't you? Unfortunately, eager investors get lured into this foolishness by hype and propaganda. If you are looking for a really simple technique that will consistently make you good and steady money with penny stocks, you should read my recent article entitled, "How To Make Money On Penny Stocks."
I've been thinking about writing this article for a while now but had put it to a back burner until now. This is because lately I've been seeing a rapid increase in the number of investors losing all or most of their money with the technique of shorting penny stocks. This is because it is being heavily promoted by certain self-proclaimed "gurus" who are making a real killing selling information on this technique. They tell you to look for things like the "triple top reversal" and they teach you other complicated charting techniques. I'm betting that they make much more from selling this type of information than they ever have actually shorting stocks.
What does it actually mean to "short a stock?" Well, it is doing exactly the opposite from what the vast majority of investors do when they purchase a stock. You see, most investors "go long" not short. In order words, they bet that the stock they are buying will go up over time and if they hang on to it for long enough time (going long) they will make money. Someone who "shorts" a stock is betting that the stock that they're buying will go down. In essence, they are betting that the company will fail. Keep in mind that when we're dealing with penny stocks, "going long" can mean holding on to the stock for only a day or a few days whereas "going long" on a blue chip stock might take years to see any significant gains. "Going long" on penny stocks, if you know which ones to trade, can be very profitable in the short term I assure you.
Let's talk about the mechanics of shorting penny stocks. To do so, you have to get what is called a "margin account" which allows you to borrow stocks from your broker. You usually have to put up a sizable amount up front which is often a barrier to many newbie investors getting involved with this type of investment (thank goodness as far as I'm concerned). However, there are a few brokers who don't charge as much up front to set up a margin account but believe me, they make up for it and then some on the fees they charge. Once you have the margin account and you want to "short" a stock, you "borrow" the stock from the broker, sell it at the current value (and the let the broker hold it as collateral), and then hold your "short order" open until you are ready to buy back the stock at a different price. You hope and pray that the stock goes down so when you buy it back, you can pocket the difference the lower price and the higher price. However, it doesn't always go down. Sometimes it goes up and you end up having to buy it back at a higher price - sometimes a much higher price, in which case you can lose big time! In addition, you have to pay "margin interest" until you settle and close your short order and the longer you wait the more margin interest you pay. These fees alone can eat up your profits.
Now, I mentioned in the first paragraph of this article that sometimes when investors short penny stocks, they end up not just losing their entire investment but actually lose more than this. I want to explain this now so you can see just how risky the business of shorting stocks can be. A stock price can't fall any lower than zero (there are no negative stock values) so the amount of profit you can make from shorting a stock is limited by this fact. However, there is no limit to how high a stock price can rise. It can double, triple, quadruple, etc... In other words, you can literally end up losing many times over the original investment when you are forced to buy back the stock at a much higher price. Yes, before you ask, you CAN place a stop loss order when you short stocks but these are so volatile if you do so you may very well end up triggering an automatic buy back of the stock back at a higher price - and there's nothing similar to a "trailing stop order" when you short stocks.
Most self-proclaimed "gurus" who promote this style of penny stock trading tell you to look for penny stocks that have been pumped and hyped in what is referred to as the "pump and dump" scam. This is where a promoter buys a bunch of worthless stock, then drives the price up artificially high by hyping it up, and then dumps all their shares at a much higher price raking in a fortune on the backs of many smaller investors who lose their shirt when the price comes crashing down and they can't sell because everyone else is trying to sell and no one wants to buy.
Now, what are the ethics of intentionally looking for penny stocks that have been pumped so you can intentionally short them before they are dumped? I personally think it is highly immoral - I despise the idea of profiting from someone else's misfortune - no, I don't care about the scammer but I do care about all the smaller investors who were hoodwinked into buying a worthless stock. It's also a real detriment to the free enterprise system of the stock market which is why shorting stocks has been banned in some countries but I will get into that issue in more depth in another post as this one is going to be long enough! However, I do want to cover one aspect of this now... please read on...
I want to give you a scenario where you can be right about a penny stock but STILL lose if you short it. Let's say you recognize a penny stock's price has been driven up to a ridiculous level for a worthless company by a pump and dump scam. You may be thinking... why don't I short this stock because I know it is going to crash - and you may be right - it may very well be destined to crash... but it may not crash right away! It may take a good amount of time for this to happen. You don't have a crystal ball (and charting is not fool proof I don't care what the supposed gurus tell you) and you can't keep a short order open forever. You are paying margin fees and your broker isn't going to let you anyway - they will call the order. Plus, maybe the scam artist isn't done pumping the stock. You see it can be very dangerous indeed to try to outwit pump and dump scammers - some of these guys are very sophisticated in how they go about tricking people. You should never try to beat them because I don't care how smart you are, you will get badly burned, maybe not the first time or even the second but overall, you will lose. Remember, what I said in the first paragraph? 99% of all people who try shorting penny stocks aren't doing so a year later - again, there's a very good reason for this!
Okay, I want to again tell you there is a much better way to trade penny stocks - better from the perspective of being far less risky - better from the perspective of being far more profitable overall - better from the perspective of being elegantly simple and not having to stress out so much in the process - better in that it takes far less time (less than an hour a week and I mean that literally) - and yes, better from the perspective of being ethical. It's all explained in my previous posts, "How To Make Money On Penny Stocks" and "Can I Make Money On Penny Stocks?" Plus, if you want to know more about how I came to these conclusions, you can read my article entitled, "Why I Love Penny Stocks So Much."
The articles linked above will get you on the right track to making really good money with penny stocks in a way that will leave you feeling good and having plenty of time for doing other things and enjoying life. As always, I encourage my readers to consider giving back - to your family, friends, strangers in need, community, and to the world at large when you strike it rich :-) I hope I have helped. Good luck to you!
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