3

Obviously there is a lot of risk involved, but I routinely see penny stocks (OTC) climb to unreasonably high levels of growth over very short periods of time (1-3 days), sometimes up to 9000% growth. I think it's obvious these are victims of pump-and-dump schemes.

Is it legal, and/or safe(ish) to attempt to capitalize once this has been realized? I'm not going to wind up in the SEC's crosshairs if I short a bunch of this stock hedging on its inevitable return to "normal" levels?

Maybe I'm missing something (newer investor) and there is a reason most other folks don't attempt this?

  • 2
    How do you identify a true pump+dump stock versus a penny stock that happens to have become a major hit? You wouldn't be making very much money shorting these stocks, particularly as you'd have to find others willing to be on the other side of these transactions, and you would risk losing a lot if you guess wrong and the stock continues to climb. – Joe Oct 1 '14 at 15:21
  • @Joe I guess I am assuming they are pump-n-dump schemes (most have flat-lined activity for 6+ months, then suddenly spike up to unbelievable levels within 1-3 days, almost always with zero news to be found regarding the company). Most I've watched do crash shortly after I notice them. My thoughts were, someone is buying these stocks up, otherwise the pump wouldn't be very effective? – SnakeDoc Oct 1 '14 at 15:37
  • 4
    The point is, maybe 90% of them will be P&D, but a few will be real - companies that suddenly got a big contract or otherwise hit it big. If you make a little on those 90% but risk losing a huge amount on the 10%, that's not a good business model. – Joe Oct 1 '14 at 15:39
  • do you think there is something "wrong" with shorting? There are regulations that limit short selling on those kind of stocks and you will also encounter issues with your brokers. – CQM Oct 1 '14 at 23:31
  • @CQM not at all, but I'd be worried if I made a substantial amount off of an obvious scheme (getting in early on the pump, or shorting the dump), even if I had nothing to do with it's orchestration. Perhaps I'm just over-worrying. – SnakeDoc Oct 2 '14 at 0:48
8

Shorting penny stocks is very risky. For example, read this investopedia article, which explains some of the problems. In general:

  • Illiquidity. Illiquidity from a small number of buyers/sellers means that you will have a hard time covering your short position, particularly if it's going the wrong way.
  • Difficulty with the transaction. You won't necessarily have all that many people willing to participate in the short sale, and if you make a naked short sale you won't necessarily be able to cover it even if it turns out to be a good move.
  • Some brokerages don't allow shorting OTC stocks (although it's legal in general) because it's a risky business that involves some risk on their side if you end up very negative.
  • Large risk for low potential gain. Why make a few dollars here and there (particularly with commissions and exchange fees) when there is a risk of a very large loss if you guess wrong? Particularly on OTC stocks, where there is often very little information available, it's very risky trading in general, and in particular in something like a short sale which has nearly unlimited risk (and particularly with the illiquidity meaning you may not be able to cover it if it's going up quickly).

If you have some sort of method for perfectly identifying Pump and Dump schemes, it's possible you could make money if you time things right, but that timing is going to be very difficult to identify.

  • 1
    Large risk for low potential gain, definitely! Better off using your analytical skills in different markets, where there are derivatives and all sorts of better more liquid ways to make gains much much greater than 90% – CQM Oct 1 '14 at 19:44
3

Assuming you have no non-public material information, it should be perfectly legal. I suspect it's not a great idea for the reasons that Joe outlined, but it should be legal.

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .