(If you want to read my previous posts, f o l l o w m e !)
Welcome to post #17.
For now, in this series, we have only discussed the other side of the market. Low and high strategy.The buy low sell high strategy. Going "long."
But let's face it – penny stock land. Almost all of these companies are crap. They hype up and dump. Gravity always wins.
What if, you could make money on the dump? How about making money when everybody else is holding the bag?
You can. It is known as Short Selling.
It’s like Wall Street voodoo, but it really is quite simple. You are simply buying a normal trade, but backwards. You sell high, and buy low.
Here is a real world example that it will 'click' with.
Suppose that your friend has a pair of rare sneakers. They’re highly hyped right now, and they are being sold for $1,000. However, you have no doubt that the hype is bogus and the price will drop next week.
You're at your friend's place and say, “Hey, can I borrow those sneakers for a few days?” He says sure.
You instantaneously remove his sneakers and sell them to someone on the web for $1,000.
Boom. You now have $1,000 cold hard cash in your pocket. But... you still need to buy a pair of sneakers for your friend.
After a week, just as you expected, all the hype goes away. The price of those sneakers crashes down to $200.
You spend $200 out of your pocket and purchase a pair of those same shoes, and give them back to the same friend. He's happy, he got his shoes back.
But you? You get to keep the $800 difference.
A Short Sell is just that.
There's no such thing as borrowing sneakers in the stock market. You are borrowing shares of a stock from your broker.
You borrow shares of the over-exhated penny stock at $5.00. Immediate sale to the open market. The promoters dump, the stock crashes down to $1.00. The shares can be repurchased at $1.00, returned to the broker and you pocket a huge $4.00 per share profit.
The companies are built to fail so shorting these micro-caps is a favorite pastime of the professional traders. It is sort of like free money.
BUT, and, I'm going to stress BUT, this is a big, big BUT.
There's nothing more risky than short-selling when it comes to the stock market.
Think about the math. If you purchase a normal stock, the worst that can occur is that the price of the stock drops to zero. You lose 100% of your investment.
However, what about a short? The ceiling is omitted. A stock can go up 1,000%. It can go up 10,000%.
Assuming you are shorting a $2.00 stock and it then skyrockets to $20.00, you are going to lose money every time it goes up. There are no limits to the amount of losses you suffer. You can end up with your broker owed an amount of money that you don't have in your bank account, and that amount is tens of thousands of dollars.
But what happens if a group of short sellers all ends up being in the same stock, and the stock doesn't go to zero? It makes the most explosive face-melting chart in the world of finance.
We refer to it as the ‘Short Squeeze’. Exactly how it works, we will dig into in post #18.