So you wanna be a penny stock trader and make lots of money in a short amount of time right? Ya, well hold your horses there cowboy! Sure penny stocks can be profitable, sometimes very profitable BUT if you don’t know what the heck your doing they can also make you broke, very broke, and quickly!
In order to be a successfully penny stock trader, what you need is knowledge, a strategy, and probably most important, the discipline to execute that strategy. So here’s my quick “penny stocks for dummies” guide to get you started in the right direction:
What is a Penny Stock?
There are a number of ways to define a penny stock but the most common is if a particular stocks trades for mere “pennies” as in less than one dollar. However there are other penny stock definitions out there that you’ll probably come across, such as any stock that trades on the pink sheets or OTC (Over the Counter) stock markets. Still another definition is based on market value, with a penny stock defined as any stock with a total market capitalization of less than 250 million. Market capitalization is calculated simply by taking the number of outstanding shares multiplied by the stock price.
What Are the Benefits of Penny Stocks?
The main benefit of penny stocks is simply that that they are, well, cheap and because they are cheap you can buy a large number of shares for a smaller amount of money. With just a small increase in stock price, your investment will gain much more quickly than a traditional blue chip stock. For example a 20 cent stock can often quite easily increase to 30 cents, often in the same day. A 10 cent price increase may not seem like much but in this case it equates to a 50% return on your investment! You don’t hear of that very often with other types of stocks.
A second benefit of penny stocks is that they typically have a smaller float (i.e. number of outstanding shares). What this means is that even a moderate amount of buying activity can quite easily move the stock up in price and rapidly.
What Are the Risks of Penny Stocks?
So what are the risks? Well, funny enough, the risks are directly related to the benefits! Let me explain. Because penny stocks are cheap and have a much smaller float, they are more easily manipulated than other stock equities. Manipulated by whom you might ask? A lot of different people, but mostly by what are known as penny stock pumpers, or the more friendly phrase penny stock “promoters”.
The sole purpose of the pumper is to manipulate the stock price by convincing others to buy it and thus artificially inflate the price. They do this so that the ones paying for the promotion (who frankly are often company insiders) can sell their shares and make some good coin. What’s so bad with that? Well, the problem is as soon as the “pumping” is over, the other traders who actually thought the price is going up for legitimate reasons are left holding the bag when the buying stops and the stock starts to plummet!
The other big risk with penny stocks is many of them of low trading volume, which means it’s much more difficult to buy and sell shares for fair market value, or even at all some trading days. So when picking a penny stock you’re generally going to want to pick one with reasonable share volume.
Trading Penny Stocks vs. Investing
It’s very important to make the distinction between trading penny stocks and investing in penny or small cap stocks over the longer term. Generally when dealing with penny stocks you want to stick with short term trades, as in either day trading or not holding them longer than a few days or weeks. Yes, there are some decent penny stocks that can keep rising over the long term but this is not the norm. Most penny stocks either stay flat or zigzag all over the place so you want to capitalize on the short but intense price movements of the ones that move. So, in short, stay with short term penny stock plays and leave investing for the blue chips or ETFs of your portfolio.