Short selling is an effective trading strategy that can be employed to hedge the risk of a loss on an off-setting position or to speculate on an equity's price movement. In essence, short selling entails selling a stock that you do not own. An investor does this by borrowing the stock and immediately selling 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 subsequently purchased.

In regards to pink sheet and over-the-counter (OTC) listed securities, short selling is allowed. An OTC security is one that is not traded on a formal exchange such as the New York Stock Exchange or the American Stock Exchange. OTC securities are often quoted on the OTC Bulletin Board (OTCBB). Pink sheet securities are very similar to OTC securities in that they are not listed on exchanges, but are quoted on a daily publication issued by the National Quotation Bureau. However, pink sheet securities carry much more risk because they do not require the companies to register with the SEC or stay current in their financial statements.

Although short selling is allowed on these securities, 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 hazardous if an investor needs to cover an increasingly unprofitable short position. If the volume is very low, covering the position may become a very unlikely prospect. Another problem that has arisen with short selling in OTC securities is the use of pump and dump schemes. These schemes are done by con artists who use internet message boards and SPAM emails to heavily promote a thinly traded stock in which they have long positions. When this happens, the result is often a high spike in the price of the stock, followed by a fall. However, the initial spike will devastate any investor with a short position. These schemes often use OTC stocks because they are relatively unknown when compared to exchange traded stocks.

To learn more, see The Lowdown On Penny Stocks, Short Selling Tutorial and the Online Investment Scams Tutorial.

  1. What is a "pink sheet" in the context of an OTC (over-the-counter) transaction?

    Read about pink sheets, the electronically driven over-the-counter market in which broker-dealers connect to trade the stock ... Read Answer >>
  2. How do I buy an over-the-counter stock?

    The process of purchasing over-the-counter (OTC) stocks is different than purchasing stock from companies on the NYSE and ... Read Answer >>
  3. Where do I go to make an OTC (over-the-counter) transaction?

    Learn about the over-the-counter, or OTC, market and how to purchase its stocks. These stocks are often risky, but some offer ... Read Answer >>
  4. What are the steps to get a company listed on the OTCBB?

    The over-the-counter bulletin board (OTCBB) is a regulated quotation service for over-the-counter (OTC) securities. The securities ... Read Answer >>
  5. How does a company move from an OTC market to a major exchange?

    The over-the-counter market is not an actual exchange like the NYSE or Nasdaq. Instead, it is a network of companies that ... Read Answer >>
  6. What does it mean when a stock trades on the Pink Sheets or the OTCBB?

    The stocks of well-known companies such as General Electric and Microsoft trade on major exchanges such as the New York Stock ... Read Answer >>
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  1. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context ...
  2. OTC Pink

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  3. Yellow Sheets

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  4. Penny Stock

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  5. Short Covering

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  6. Unlisted Security

    A financial instrument that is not traded on an exchange, but ...
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