Many traders look at the daily up and down lists in their filters and find over-hyped low-priced stocks that may be favorable for short-selling opportunities.
But when they shorted the stock, their broker frustratingly stopped them and asked the trader to ask “Why can’t I short some low-priced stocks?”
The short answer is because of your The broker could not find any stocks available for you to borrow.
There are many reasons for this to happen, and we will introduce them in detail in this article.
To fully understand why you can’t short some penny stocks, we need to understand the short selling mechanism of the stock market.
When you short stocks, you are selling stocks that you do not actually own. It may seem strange that you can sell things you don’t own. You may ask: “Isn’t this like creating a new share?”
But this is completely normal, you are only temporarily borrowing shares from someone who owns them.
You sell them first, then buy them back, returning the stock to the rightful owner. If you make a profit between the two, then your transaction is good.
The following is how the process generally works, although it is now automated. You will not call your agent to arrange a location.
- You decide to short stock XYZ
- You call your broker to find XYZ stocks so that you can short them.
- Your broker calls mutual fund A, which has a large amount of XYZ, to see if they can lend you some. The mutual fund agrees to lend you stocks at an interest rate of 0.5%.
- You now have your position and you can short the stock
Your stock is on the hard-to-borrow list
When selling short at a US broker, you can divide stocks into two tiers: easy to borrow and Hard to borrow.
It’s easy to borrow stocks like Apple (AAPL) Or Johnson & Johnson (Johnson). There is almost always a large number of stocks available for borrowing, and you don’t need to locate them manually. When you try to short them, it’s as if you have already borrowed them.
You need to manually locate stocks that are difficult to borrow. Usually it is as simple as entering the stock code and the number of stocks you want to short in their positioning screen, which is usually hidden in the menu of their trading platform.
The problem is that they are called hard to borrow for a reason, because it is hard to borrow them, so sell them short.
You can think of borrowed stocks as a market in themselves.
Because interest rates are paid when borrowing stocks to go short, there is a supply and demand mechanism in the borrowing market. When everyone wants to short the same low-tradable stocks at the same time, there is too much demand and too little supply.
When you encounter difficulties in borrowing stocks that are difficult to borrow, there are two possible scenarios: (1) Your agent’s location is not good, Or (2) Everyone has a bad position, and no one can find a position on the inventory.
You can partially overcome these problems by using a broker that more professionally locates stocks that are difficult to borrow. We will discuss it in a later section.
Why are some stocks hard to borrow?
The short answer is supply and demand.
Just like everyone buying Bitcoin will push up the price, everyone wants to short the same stock at the same time, so it is difficult to borrow because there are few stocks available for borrowing.
This usually occurs in stocks with low public float.
The circulation of stocks refers to the number of stocks that are circulated on exchanges without additional restrictions. Think about the sudden news of a low-tradable stock that never changes. With the same number of outstanding shares, the trading volume of stocks has doubled several times.
So almost no stock can be circulated. When there are major breaking news, it is not uncommon for the stock trading volume to be several times its daily floating volume.
Of course, when there are few outstanding shares, fewer shares are borrowed.If you haven’t opened a fancy high-net-worth account with a famous bank like Goldman Sachs, you probably won’t see these positions
Your broker does not allow you to short stocks
In 2021, with the emergence of crazy short-squeeze in stocks such as GameStop, it has become more common for brokers to manually restrict customers from buying and selling certain stocks.
In the era of memetic stocks, when shorting the hyped stock, the risk of your account being blown up and owing your broker money is much higher, so sometimes the broker feels it necessary or even not allow you to short it.
When you short a stock, you borrow the stock from your broker and let your broker become your creditor. They are not obligated to provide you with credit to bear the huge risk of shorting penny stocks, just as you are not obligated to continue to provide them with your business.
There is a key difference between a broker cutting off a client’s cash-backed position to buy meme stock and expanding a client’s credit to short the same stock.
In this case, your only option is to use a different broker. If you often short low-priced stocks, you may have opened multiple brokerage accounts.
How to find stocks that are difficult to borrow
The easiest way to find stocks that are difficult to borrow is to use a broker that specializes in this practice. Stock lending is still a relationship business, and retail brokers who do not develop lending services will not have the best lending.
Here are some brokers that low-priced stock traders usually praise:
However, you get what you paid for.
Not only are the minimum deposits of these brokers higher than the average (usually from around $25,000), they also charge higher fees for their services. Unless you conduct a large number of transactions and pay a monthly fee for the trading platform, you are expected to pay a commission of approximately $0.004 per share.
Another way is to open accounts with several mainstream retail brokers such as Schwab. TD Ameritrade Securities, ETrade, etc. This is the power of a number game.
Although none of these brokers alone have a good positioning of penny stocks that are difficult to borrow, combining their positioning will sometimes allow you to find positions that you think you cannot obtain. But don’t get me wrong, penny stock traders are not the target customers of these brokers, and their poor position reflects this, so don’t expect too much.
Another way is to join a proprietary trading company, which usually has prime brokerage relationships with top banks, ensuring higher quality loans than retail brokers.
It’s frustrating to get ready to trade but be interrupted by the “HTB” indicator in your trading platform. But, you know what they say, “The enemy of art is unlimited.”
This may sound strange, but sometimes setting up obstacles on the road can help you stay patient.
If you are used to finding trading ideas and not accepting them, once the chart looks interesting, it will prevent you from impulsively hitting the hotkey.