A:

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.

RELATED FAQS
  1. 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 >>
  2. What are the risks involved in OTC (over-the-counter) trading?

    Learn about the significant disadvantages and risks that are involved for investors seeking to trade in over-the-counter ... Read Answer >>
  3. 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 >>
  4. 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 >>
  5. What are the SEC (Securities And Exchange Commission) rules about OTC (over-the-counter) ...

    Find out how the Securities and Exchange Commission and the Financial Industry Regulatory Authority regulate trades on the ... Read Answer >>
  6. What does it mean when a stock symbol has a .PK after it?

    The .PK is an example of a suffix representing where the security is traded - an over-the-counter (OTC) network or an international ... Read Answer >>
Related Articles
  1. Investing

    How To Play The OTC Pink Stocks

    The OTC Pink offers a variety of investment candidates including many good companies waiting to be discovered. Recently, the OTC Pink has worked hard to improve the service by tiering companies ...
  2. Markets

    The Over-The-Counter Market: An Introduction To Pink Sheets

    Being early to a party may not be hip, but being early on a rising stock certainly is.
  3. Markets

    Getting To Know The Stock Exchanges

    Here are the answers to all the questions you have about stock exchanges but are too afraid to ask!
  4. Investing

    Why You Should Understand The Stock Market

    Even if you don't invest a cent in stocks, you should still understand how the stock market works. Find out why.
  5. Markets

    Trading Over the Counter

    OTC trades tend to be for smaller company stocks and debt securities. Debt securities such as bonds are generally traded by investment banks making markets for specific issues.
  6. Investing

    Guide to Short Selling

    Want to profit on declining stocks? This trading strategy does just that.
  7. Investing

    Short Selling: Introduction

    Have you ever been absolutely sure that a stock was going to decline and wanted to profit from its regrettable demise? Have you ever wished that you could see your portfolio increase in value ...
  8. Investing

    A Look At Primary And Secondary Markets

    Knowing how the primary and secondary markets work is key to understanding how stocks trade.
  9. Investing

    The Basics Of Short Selling

    Short sellers enable the markets to function smoothly by providing liquidity, and also serve as a restraining influence on investors’ over-exuberance.
  10. Investing

    Short Interest: What It Tells Us

    This figure can be a real eye-opener about the market sentiment surrounding a given stock.
RELATED TERMS
  1. Over-The-Counter - OTC

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

    The lowest tier of the three marketplaces for trading over-the-counter ...
  3. Over-The-Counter Market

    A decentralized market, without a central physical location, ...
  4. Yellow Sheets

    A United States bulletin that provides updated bid and ask prices ...
  5. Unlisted Security

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

    Short selling is the sale of a security that is not owned by ...
Hot Definitions
  1. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  2. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  3. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
  4. Brexit

    The Brexit, an abbreviation of "British exit" that mirrors the term Grexit, refers to the possibility of Britain's withdrawal ...
  5. Underweight

    1. A situation where a portfolio does not hold a sufficient amount of a particular security when compared to the security's ...
  6. Russell 3000 Index

    A market capitalization weighted equity index maintained by the Russell Investment Group that seeks to be a benchmark of ...
Trading Center