Description

My basic trading philosophy can be summed up by one simple quote:

"Trade the ticker, not the company" - Nate Michaud


Tuesday, February 4, 2014

Question: "What is the $2.50 rule?"

After my post about brokers that I use and recommend, a few people were asking what exactly the $2.50 rule is. Fair enough; let me clear that up.

The $2.50 rule applies when you are short selling stocks that are priced under $2.50. Basically, the rule states that for every share you are short, you still need to put up $2.50 of capital, even if the stock is priced lower.

Why does this matter? Let's say you have a $1000 account and you want to short sell pennystocks. If the stock is under $2.50, you will not be able to take a full $1000 position, even if you wanted to. Here's the math:

You have a $1000 account;

For ANY stock under $2.50, you must still put up $2.50 in capital.

Divide $1000 by $2.50, and the MOST shares you can short is 400 shares, REGARDLESS of price.

This can be a huge frustration for small accounts. You might have the perfect supernova chart and the stock is trading at $1, but you can't short 1000 shares. You can only short 400 because of the $2.50 rule.

Here are a few examples of the MOST shares you can short based on your account value:

$1000 account   -   400 shares max
$2500 account   -   1000 shares max
$5000 account   -   2000 shares max
$10,000 account -  4000 shares max
$25,000 account -  10,000 shares max

The cheaper the stock, the larger a disadvantage this is because of the smaller $ position size you will ultimately wind up taking. Unfortunately, it's one of the realities of short selling but as your account grows, it will become less of a nuisance. I hope this helps clear up any confusion!

25 comments:

  1. I really appreciate the information, it is really helpful. It really makes things easier for us newbies, and even more so for the newbies who are in a similar situation as you. I will have the site on watch from now on for sure.

    ReplyDelete
  2. it helps a ton thanks, could you also explain why it exist ?

    ReplyDelete
    Replies
    1. The 2.50 rule mainly exists to help brokers protect themselves from taking on too much risk. Sometimes it is very easy to short too early on these parabolic charts, and if you're stubborn rather than cutting your loss it's very possible to be down 100% or more on the position. Brokers enforce the 2.50 rule because the cheaper the stock, the easier it is for it to have big moves that could crush a short seller's account. So the 2.50 rule keeps clients from being able to go all in short on a $0.10 stock, and the broker is better protected

      Delete
    2. Good quality penny stocks are actually less risky than the more expensive stocks. What a pity these guys in the brokerages don't keep up with reality. See Forbes’ Asness review: ‘Big News From AQR: Size Matters, If You Control Your Junk, Forbes, 2015.
      http://www.forbes.com/sites/phildemuth/2015/01/26/big-news-from-aqr-size-matters-if-you-control-your-junk/#ecdb3e522c3c

      Delete
  3. Tim great post! This makes so much more sense now! Thanks.

    ReplyDelete
  4. Tim - is this refereed to Freeriding?

    ReplyDelete
  5. Any chance you could explain why a stock like SOUL goes from $1.50 to over $14 on relatively low volume, and there has been significantly higher volume since mid-December, yet the stock has barely moved (see 1 year daily chart). Thanks

    ReplyDelete
  6. SOUL had a stock split, meaning they increased the # of shares outstanding which also made the price cheaper. At the time SOUL wasn't really that expensive, the chart just got altered because of the split

    ReplyDelete
  7. What about larger accounts? Should/does this rule remain the same?

    ReplyDelete
  8. Great post, I am going to be reading your blog on the daily basis. You have great information. Thank you for sharing your knowledge.

    ReplyDelete
  9. Say you purchase 10,000 shares of a stock at $1.00 a share and the $2.50 rule causes your account to be charged $25,000, ($15,000 more than the share price). My question is when you sell the stock (ex. $1.15) is your account immediately credited the $15,000 so you can trade immediately or do you have to wait the 3 day period for your funds to become settled? Thanks, Tim.

    ReplyDelete
    Replies
    1. The extra money that was tied up should become immediately available

      Delete
  10. Hey Kroy, I notice you short some StockMister picks (ITCC).. I'm looking to short all his pumps this summer, but what broker do you use? I am thinking SureTrader, but I don't know if they will have shares of his obscure picks

    ReplyDelete
  11. Tim, when you started trading you said you had $1,500.. Did you go all in every trade?? or did you use 50% of your money? how long did it take you to go from $1,500 to $10,000??

    ReplyDelete
  12. My broker is applying the $2.50 rule to going long!!!!!!!! Can you believe it?

    ReplyDelete
  13. Thanks for the information Tim. How much did you learn from Tim Sykes?

    ReplyDelete
  14. Hi Tim, what happens when a stock above $2.50 say, a $10 stock crashes and falls below the $2.50?

    ReplyDelete
  15. This comment has been removed by a blog administrator.

    ReplyDelete
  16. Do you think that to dramatically improve your success rate you have to read tons of thick books, buy expensive software and spend countless hours of learning more about Forex?

    What I'm going to share with you is something very EASY to use and very POWERFUL at the same time.

    Let me give you an EXAMPLE:

    Imagine you trade a system that makes 50% winning trades, but another 50% are losing trades. If you increase your odds of winning by only 20%, that would make 70% winning trades and 30% losing trades.

    Well, HOW TO accomplish that?

    Just pick the best trending pair at the current time and simply follow the trend! I have found ONE INCREDIBLE TOOL that continuously scans the Forex market and picks the most reliable trending pairs for you.

    ==> http://www.forextrendy.com?ljsjhd8374h

    By taking signals in the direction of a strong trend you would REDUCE UNNECESSARY LOSSES and increase the odds of winning. You need to know "how well" the market is trending to avoid very short-term trends.

    STOP hunting the market for every potential trade. Pick only the best trending pairs and time frames and DO NOT take any trading signals in the choppy market (unless you know exactly what you are doing).

    Successful traders keep it simple and this is the way how the pros made fortunes in the markets - by trading less and making more.

    To increase the profitability of any system or robot you are currently using, check out this easy and powerful ultimate solution:

    ==> http://www.forextrendy.com?ljsjhd8374h

    ReplyDelete
  17. http://www.arena-multimedia.com/blog/website-designs-whats-trending-this-year/#comment-24507

    ReplyDelete
  18. "Which Forex pair and time frame is best to trade" is the frequently asked question and I want do give you the DEFINITE ANSWER.

    Are you expecting that I am going to say something like EUR/USD on 5-minute time frame or GBP/USD on daily...? No, it is not so simple, but SIMPLE ENOUGH we can figure it out!

    The "PROBLEM" is that markets change over time. If GBP/USD was a well trending currency pair a few years ago, today it is another one.

    I actually want to let you know about a SPECIAL TOOL that I use to find the BEST TRENDING PAIRS among all the Forex pairs.

    ==> http://www.forextrendy.com?hfsdtb63546

    The software scans 34 Forex pairs on all time frames from minute to monthly. This way you pick the best trending pair and time frame at the current time.

    The system is running on our powerful computers, so you have nothing to download and install. Just join in and start using it within a FEW MINUTES! Get it on the link below:

    ==> http://www.forextrendy.com?hfsdtb63546

    ReplyDelete
  19. "Which Forex pair and time frame is best to trade" is the frequently asked question and I want do give you the DEFINITE ANSWER.

    Are you expecting that I am going to say something like EUR/USD on 5-minute time frame or GBP/USD on daily...? No, it is not so simple, but SIMPLE ENOUGH we can figure it out!

    The "PROBLEM" is that markets change over time. If GBP/USD was a well trending currency pair a few years ago, today it is another one.

    I actually want to let you know about a SPECIAL TOOL that I use to find the BEST TRENDING PAIRS among all the Forex pairs.

    ==> http://www.forextrendy.com?hfsdtb63546

    The software scans 34 Forex pairs on all time frames from minute to monthly. This way you pick the best trending pair and time frame at the current time.

    The system is running on our powerful computers, so you have nothing to download and install. Just join in and start using it within a FEW MINUTES! Get it on the link below:

    ==> http://www.forextrendy.com?hfsdtb63546

    ReplyDelete