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!