The Power of the Short

We all know penny stocks are dangerous to buy. People pump penny stocks, forcing them to rise without reason. This creates a highly unstable environment, and the ONLY thing that is certain is the fall of the stock. So my thought has always been, why participate, and most likely lose, in the pump, when I can far more easily get into the almost guaranteed dump? With this idea in mind I went to work thinking of a basic screener that I could use to capture over-bought penny stocks and simulate what would happen in the event they were purchased, or shorted. After a little playing around I came up with a very basic screen.

This screen, though extremely basic provides many of the aspects I, or anyone else, would look for in a penny stock they intended to short.

  1. Close < 5
    1. This is simply stating that last closing price of the stock is under $5.
  2. (average(Volume X Close) within 20 days) > 1m
    1. In order for you to be able to short a stock someone must hold a long position in a margin account somewhere. This line not only helps to assure someone is holding shares in their account for you to borrow, it also increases your chances of actually having your order filled when you go to sell it, or buy it back. No one wants to be left holding worthless shares. And you don’t want to be in a completely iliquid position.
  3. Change of close over 5 days > 50
    1. This is the kicker. Basically, this line only picks companies whose stock price over the last five days has risen by 50% or more. Now, the charts below are even more dramatic the higher you make this number. However, they weren’t as aesthetically appealing as there was a lot of time where you would simply be waiting for that one stock to sky rocket that also fit the other two parameters in our list. 

So how did it do?
Is it really as bad as it looks? Let’s log scale it.

…not so hot if you’re a buyer. However, as a seller this looks fantastic! We lost ALL of our money. Never have I been, nor will I ever be this happy to be losing money again. But in this simulation, losing money means we’re making money. Now I know a lot of you are looking at the chart kind of disappointed that it’s set all of the way back to 1995, thinking that you’ll need to wait 20 years to see any real profit. So I’ve attached a couple more charts, just for you guys. 

As you can see, we are still getting massive returns/losses if we adjust the time to only five years…what? you guys still aren’t happy? Ugh, here’s another photo. 

Are you guys happy yet? No? Fine I’ll post one more. I will crunch the time frame down to four months and show you guys just how great shorting these pumps is, and why you should never yourself buy into a pump. 

Wow! That’s almost a 50% return, or loss if you’re going long, when you short stocks that follow this pattern.

About Aaron A

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