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. What happens to the shares of a company that has been liquidated?

    The fate of a liquidating company’s shares depends on the type of liquidation the company is undergoing. The most common ... Read Full Answer >>
  2. What is a derivative?

    A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset, ... Read Full Answer >>
  3. What is after-hours trading? Am I able to trade at this time?

    After-hours trading (AHT) refers to the buying and selling of securities on major exchanges outside of specified regular ... Read Full Answer >>
  4. Do penny stocks trade after hours?

    Penny stocks are common shares of public companies that trade at a low price per share. These companies are normally small, ... Read Full Answer >>
  5. Do penny stocks pay dividends?

    Because of the small market capitalization and revenues typical of most penny stocks, there are very few that offer dividends. ... Read Full Answer >>
  6. Can you buy penny stocks in an IRA?

    It is possible to trade penny stocks through an individual retirement accounts, or IRA. However, penny stocks are generally ... Read Full Answer >>
Related Articles
  1. Stock Analysis

    The Top 10 Small-Cap Stocks for 2016 (ATI, ARCB)

    Discover the top 10 small-cap stocks expected to grow in 2016, complete with summaries and growth outlooks for each company and its expected price target.
  2. Investing News

    Today's Sell-off: Are We in a Margin Liquidation?

    If we're in market liquidation, is it good news or bad news? That party depends on your timeframe.
  3. Stock Analysis

    The Top 5 Gold Penny Stocks for 2016

    Discover five penny stock gold miners that are well-positioned to profit in 2016, providing opportunities for investors to make significant gains.
  4. Stock Analysis

    The Top 5 Platinum Penny Stocks for 2016 (PLG, XPL)

    Examine five penny stocks in the platinum mining business that investors may wish to consider adding to their investment portfolios for 2016.
  5. Economics

    The History of Stock Exchanges

    Stock exchanges began with countries who sailed east in the 1600s, braving pirates and bad weather to find goods they could trade back home.
  6. Stock Analysis

    The Top 5 Small Cap Entertainment Stocks for 2016 (CKEC, RDI)

    Learn about these five small-cap entertainment stocks that deserve a spot in your portfolio for 2016. Take advantage of trends across the industry.
  7. Mutual Funds & ETFs

    The 3 Best Downside Protection Equity Mutual Funds

    Learn how it is possible to profit in a bear market by owning the correct selection of mutual funds that provide downside protection and opportunity.
  8. Investing Basics

    How To Invest In Penny Stocks

    Penny stocks are highly speculative and very risky for many reasons, including their lack of liquidity and small market capitalization.
  9. Mutual Funds & ETFs

    The 5 Best US Small Cap Value Index Mutual Funds

    Find out which index mutual funds do the best at investing in small-cap value stocks for higher potential returns at the lowest cost.
  10. Stock Analysis

    The Top 5 Entertainment Penny Stocks for 2016 (SIRI, ZNGA)

    Learn more about what types of businesses comprise the entertainment industry, and discover five entertainment penny stocks for investors to consider in 2016.
RELATED TERMS
  1. Bear Closing

    Purchasing a security, currency, or commodity in order to close ...
  2. Crowded Short

    A trade on the short side with an overwhelmingly large number ...
  3. Gross Exposure

    The absolute level of a fund's investments.
  4. David Einhorn

    Known for his short selling strategy, activist investor David ...
  5. Short Call

    A type of strategy regarding a call option, which is a contract ...
  6. Long-Short Ratio

    The amount of a security available for short sale compared to ...
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center