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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?

Bob Baerker
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SnakeDoc
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2 Answers2

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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.

Joe
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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.

David Rice
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