Shorting Parabolic Stocks
Stocks that seen an exponential decrease and an increase in stock price are called parabolic stocks.
Be careful as it could be a short squeeze too causing a jump in prices.
In this article, we will discuss shorting parabolic stocks.
Shorting Parabolic Stocks Introduction
Today, we will discuss the short-selling of a parabolic move that takes place within a stock that increases too much.
Why would people want to short parabolic stocks? Most parabolic stocks go back to their original price; that’s why traders prefer short selling of a parabolic move.
These stocks are usually penny stocks that got pumped by speculators because it is expensive to pump bigger companies.
When very small companies choose to remain publicly traded, there is always a red flag. Outside of the small stocks, parabolic moves are uncommon.
Nowadays, businesses can even get private equity financing without facing any issue of listing on an exchange. They need not deal with public shareholders and fill the SEC documents.
When you set a filter on your stock screener to look for $1B+ companies that are up to 10%+ on that day, you will notice that your watch list is small. Now change this filter to lower than $100 million and feel the difference. You might get a sizeable list every day.
This unusual market activity is mostly due to news, and you have to make sure that whether the news is to pump the stock price or this change will be reflected in the long-term in a company stock price. When a stock is pumped, mainly there are stock promoters, insiders, and traders playing the move, but that increase won’t last long. All these participants will liquidate their position soon, and the price will come back to the pre-breakout price.
However, when the news is real, it reflects a fundamental change in the company. Small hedge funds and savvy individual investors take part in the stock movement, and they hold it for long-term and hope that price will stay above the gape up point.
Characteristics of Parabolic Stocks
Some companies release a blowout earnings report, and some companies pivot from selling iced tea to blockchain projects. We want to focus on companies releasing this press release and won’t analyze financial statements.
Press Release and PR
Management is mostly concerned with the promotion of company stocks instead of products and services. They must be served as a red flag to any prospective investors. Red flags are great for short-sellers. Management teams pump the prices of stock by press releases with exaggerated claims. Their responsibility is to hire “investor relation” firms for promoting press releases on behalf of the company. These firms have expertise in promoting stocks, and they know which language can urge investors to buy shares. Promotional firms also have their stakes pushing up the price and selling their own shares during this pump.
History of Shareholder Dilution
Almost every company dilutes its share up to some extent. There is a negative correlation between the number of shares company issues and the company's quality. These companies prefer to raise capital by selling their equity instead of raising debt because they would have to pay a significant amount of interest on the debt. Companies who don’t value long-term shareholders and raise money through equity selling are like a money printing press.
Use of PIPE
It is the easiest way that companies use to raise their capital quickly. PIPE stands for Private Investment in Public Equity. The company sells restricted shares to accredited investors in the form of hedge funds and at a discount price. Moreover, there are fewer regulations for this practice, and companies can raise capital quickly through this type of offerings. In PIPE, companies add more shares and dilute the rest of the shareholders.
Investors who buy restricted shares can’t transact on a public exchange until they have resale registration statement with SEC. So, at this stage, restricted shares are sold to the public allowing buyers to liquidate their positions. These registration statements can be found in S-1 and S-3 forms with SEC.
Warranty Overhead Supply
Companies can raise capital in multiple ways, and issuing a warrant is another way. A warrant is an option contract, and companies issue it. It is different from the options contract because it only allows you to buy a warrant. They are mostly offered by the US stockbrokers and traded over the counter. We are not talking about buying or investing in warrants, we are just talking about look at the filings and see at what prices, holders of these warrants are going to exercise them.
However, warrants are not common in US markets. So, you will have to pay attention to see which companies are issuing warrants. Experienced traders always consider stock’s capital structure in their pre-trade analysis. This step is crucial because it guides us to trade these penny stocks that have made huge parabolic moves. You never know when the parabolic move will start to lose momentum. These moves generally last for a few days before gaining their pre-breakout prices.
Analyze the Financials
Short term traders don’t perform fundamental research on companies they are going to trade. Most of them don’t even know how to perform this fundamental analysis. When you look at shorting parabolic stocks, you must understand the company’s financial position. Digging into filing is beneficial, and it is necessary to avoid getting blindsided.
However, you can become an expert on corporate finance in a short period of time. So, look at the following things that you need to know for trading within the stocks.
- Cash Burn
- Current Ratio
How to Find Parabolic Stocks?
You need to apply a few filters on a stock screener to find parabolic penny stocks. You can apply some liquidity filters, such as:
- The stock price must be > $0.50
- Percentage change > $10
- Average dollar volume >$1 million
- Exchanges: NASDAQ and NYSE, and best to exclude OTC.
The risk/reward is usually very low or negative so no one will do this (shorting cheap stock has a minimal reward for big risks).
Sky Hoon. Read Full Bio
Website Owner, Twitter-er
He has been trading since 2008. He started this blog to share the journey about option trading. He dabbled in stocks, bitcoin, ethereum (in Celsius Network), ETF (lazy Dollar Cost Averaging) and also built websites for fun. He used this as a platform to share my experiences and mistakes in trading, especially options which I just picked up.