To Short? Or Not To Short?

When I first started in the business, one of the trading strategies that interested me the most was the concept of shorting a stock.

 

To those that don’t have any experience with this trading tool, short selling can be used to hedge the risk of a loss on an off-setting position or to speculate on an equity’s price movement.

 

Basically, shorting a company is selling a stock that you do not own.

 

The investor “borrows” the stock and immediately sells it in the market. If the price of the stock goes down, the investor makes a profit by purchasing the shares and delivering them to the individual from which they initially borrowed them.

 

The profit arises from the difference between the stock’s price at the time it was borrowed and the price at which it was purchased…

 

And to be honest, the concept was wholly foreign to me. I couldn’t grasp why somebody would want a stock to fall and, not to sound like a tree-hugging hippie but, I thought the whole process just seemed too negative.

 

To me, it just made more sense to root for success than failure…

 

But almost a decade in and my inner capitalist now awakened at the prospect of making money in any legal way possible – I now not only understand shorting stocks – but welcome the chance to make some money from a temporary dip in price.

 

However, back when I was REALLY wet behind the ears – I was told that while shorting stocks on the Dow, NASDAQ and S&P were common practices – I was told that shorting Pink Sheets and OTC wasn’t…

 

In fact, I was told it was technically illegal – so I avoided it.

 

Man… what a difference 7 to 8 years makes! Since then, I’ve learned a lot about shorting stocks. Such as…

 

Short selling IS allowed on both the Pinkies and OTC… although it is not without its problems.

 

Short selling on OTC is extremely risky because these securities are often very thinly traded, which makes them very illiquid. This illiquidity can prove especially dangerous if an investor needs to cover an increasingly unprofitable short position.

 

If the volume is very low, investors may have a better chance at buying beachfront property in Arizona than covering their short position.

 

But that is the risk you take for the chance at profits.

 

Now that I’ve got some experience behind the wheel – my opinion on shorting has changed. While I have no problem shorting stocks on the American Exchanges – I still stay away from shorting Pinkies and OTCs.

 

Why?

 

Simple. While some subscribe to the idea that “any profit is good profit” – I feel that the risk/reward quotient is heavily favored towards risk.

 

While the profits you can grab from a penny stock dropping $.10 is HUGE, percentage-wise – in the long run – it’s a drop in the bucket. If I’m going to short anything…

 

It’s going to be the big boys.

 

To me, there’s more profit to be had in getting in early on a promising Pinky or OTC and actually letting it run, than taking 10% to 40% (or more often than not LOSING money) on shorting.

 

I’ve been lucky enough to be a part of some BIG winners in that department?

 

Remember LOTE last year?

 

We were able to get in at $.96 a share – not too expensive but not exactly “cheap” either. However, this thing ran like it was being chased by the devil himself…

 

Eventually, this thing exploded to more than $23! Had you been lucky enough to invest just $2K in LOTE you could have walked away with FAST $43,900 profit!

 

And in my eyes, watching a stock run is a lot LESS stressful than hoping for it to go down…

 

And I already have enough gray hairs.