Options for Short Selling Penny Stocks

Short sellers try to catch penny stocks as they are dropping in price.

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Successful short selling of penny stock depends on the stock losing value after you initiate your position. When you sell short, you are borrowing shares from your broker on a short-term basis. Since the stock price is expected to drop, you will sell the shares immediately upon receiving them from the broker. You can then repurchase the stock at a lower price before it is time to repay the broker. The most difficult part of short selling is finding a broker willing to extend a loan.

Factors to Consider

Compare margin requirements when deciding which broker is right for you. Some brokers may charge a minimum margin per share, which hurts penny stock investors because the share prices are so low. For example, a margin requirement of $2 per share can make it difficult to short a stock with a value of only 40 cents per share. Make sure the broker actually has enough shares available to cover your entire trade. Check the difference between the bid and ask prices before initiating a short position to see if you can make enough profit.

Margin Calls

Because short selling is done on credit, most brokers will require you to hold a minimum amount of capital in your account to cover any losses. If the funds are not sufficient, the broker may issue a margin call. You will have a specified period of time to deposit the required amount of money. If you cannot meet this demand, the trading activity in your account will be suspended and some of your stocks may be sold to cover the debt.

Traditional Brokers

Traditional brokers such as Merrill Lynch and Fidelity offer stability and name recognition, but may impose strict regulations on your trading activity. You may have a difficult time finding a traditional broker that will allow you to short sell penny stocks. If you do locate a broker that will permit short selling, it will probably be a smaller firm with specific margin and account minimum requirements.

Online Brokers

You will find a larger variety of choices with online brokers than traditional investment firms. You are more likely to find a broker that allows shorting penny stocks this way, but major online brokers such as eTrade and TD Ameritrade still prohibit short selling of over-the-counter stocks, which rules out most penny stocks. You will have better luck with smaller brokers such as Sure Traders, Interactive Brokers and SpeedTrader.