Short selling of a stock is defined as selling a stock that the seller does not own. It does sound a little unclear but it’s all short selling is about. How does this work? Investors borrow securities from brokers expecting that the price per share will decrease. They do not own those securities, yet they can sell them.
Since short selling a stock means you borrow the shares, then you will have to give them back somehow. Those shares come from your brokerage inventory, once they are lent to you nothing else can be done with them. How do you repay those securities? To return those securities to your broker you will have to actually buy the same amount of shares you have borrowed from your broker and return them back to your broker, which is called covering.
When the price drops to a desirable level the trader buys the shares to return to the broker and keep the profit. But on the other hand, if the price rises they will still have to buy the shares and accept the loss which is not the goal of short selling.
Although there is not a time limit to get your position covered it does cost some money to hold onto a short sell. Since investors make profit when the price decreases some of them would hold until that does happen which cost them some fees if it’s a margin account.
Very rarely investors are forced to cover their short sell when the shares are needed. If you are holding a short sell for too long and the brokerage wants them back, you won’t have any choice but to cover. Being forced to cover is also known as “Called away.” It is very rare but it does happen in some cases where brokers have to make this decision.
Is This Strategy Used In Penny Stocks Trading?
Short sell is allowed in the blue chip stocks market as well as in the penny stocks market. As you know by now, penny stocks trading is very risky. Short selling penny stocks is also risky for any investor due mostly to all the scams. For example, you would not want to short sell a stock that’s being pumped. A pumped stock has a tendency to increase in price per share followed by a brisk collapse. The price per share would most likely drop to the baseline after being pumped up.
Nevertheless, some traders do utilize this strategy and manage to make huge profit. If you are a new trader I would not advise you this route as it requires experience to know how to use it in your advantage. Although it has been very beneficial for some traders, it had gone against many others.
Penny stocks are traded very thinly because of illiquid. This makes it even harder for investors to cover a short sell. Keeping a short sell stock while the volume is low is a recipe for a disastrous portfolio. Traders who short sells are usually confident in their decision and also very disciplined. If you are not disciplined it may not work in your advantage; moreover, if you are not disciplined penny stocks trading is just not for you.
Always ensure that you are trading the way that has been proven beneficial to you. If a strategy or method is working well for you, then there should not be any reason to change it. But if it’s doing the opposite then you have to look for your positive strategy. Until then, good luck and trade smart!