Penny stock trading is not a new form of stock transaction but it has grown in popularity in recent years due to two different factors. The advances in communication technology have made it possible for independent traders to make those split-second purchases and sales that can often be the difference between profit and loss with these low-priced securities. Also, an increasing number of online brokers have also begun to lower the barriers, such as excessive fees for penny stock trading, which previously made this sort of trading prohibitive. Now that so many are involved in this practice, a number of educational websites and tools have sprung up on the web in order to aid people entering this trading arena for the first time.
What Is A Penny Stock?
There is not any set definition of what makes a stock a penny stock. Many would take the name at face value and define penny stock trading as any trading in shares that are valued at less than one dollar apiece. Others expand the definition to include shares issued by public companies that trade at less than three dollars, while still others raise the bar to five dollars. The truth is that the mere monetary value of the stock does not suffice to describe a stock as a penny stock. The definition of penny stocks can be centered on their share price, their market capitalization and their reporting procedures.
Penny stocks are sometimes referred to as micro cap stocks. This appellation gets at the real definition of penny stocks. Penny stocks are best defined as those issued by companies with small market capitalizations. Occasionally well-established companies with larger capitalizations can experience a slump and see their share price descend to penny stock levels. However, they remain a class apart from most penny stocks. There are other defining factors that determine whether a stock is a penny stock.
One of the dangers involved in penny stock trading arises due to another typical characteristic of these stocks. They are issued by small companies that are not able, or not willing, to meet the reporting requirements of the Securities and Exchange Commission. Penny stocks offer little, if any, information to the public. For this reason they are not traded in the major exchanges and are only found in the over-the-counter market.
Why Is Penny Stock Trading So Attractive?
You might wonder why stocks that are valued so lowly are so attractive to some traders. Some independent traders are drawn to these stocks because of their inexpensiveness. It is easy to buy a great many penny stocks and control most of a company’s stocks with a modest purchase. Most traders involved in these trades are looking to make short term gains from fluctuations in price that have greater significance with low-priced securities. Certain traders are out there looking for diamonds in the rough and are hoping to make a fortune when these companies are recognized for their hidden qualities.
Since some penny stocks are literally worth pennies, a trader can sometimes buy millions of shares with a large investment. This gives that trader much more influence than he or she would normally have when investing in just a few thousand shares of a large cap company. Some traders like the sense of power they get from this ownership.
The vast majority of the people that engage in penny stock trading are looking to take advantage of the stocks low price. When a stock is worth just five cents, the slightest fluctuation in price can have an incredible impact on your portfolio. If that five cent stock manages to rise just five cents in value it will have doubled the size of an investment and make possible a 100% return. That same five-cent fluctuation in a large cap stock would be fairly meaningless. In the world of penny stock trading, this sort of price change is significant enough to warrant a quick sale for profit.
Certain traders get involved in penny stock trading because they understand that many great companies of today were once penny stock companies. They started out undervalued and eventually convinced the market that they had something special. In return, their prices soared and made their initial investors very wealthy. The penny stock markets are home to traders seeking these diamonds in the rough.
Are There Risks To Penny Stock Trading?
Penny stock trading is an extremely risky venture. While many look forward to profiting from sudden price changes, most penny stock traders suffer from the dire truth about these investments. These stocks are issued by companies that often have shady backgrounds, suffer from incompetent leadership or simply do not possess the means to be successful. Their prices generally stay low and the hoped-for increase in value often remains nothing more lucrative than hope. Worst of all, these traders can fall victim to schemes that unethical traders implement in order to profit from these stocks desperate situations.
The Pump And Dump Scheme
Sometimes a dishonest trader will invest a great deal in a virtually worthless stock. In order to make money from this investment, the trader then begins to hype the stock by whatever means possible. This may require him or her to set-up websites promoting the stock as the next big thing and send out thousands of emails encouraging unsuspecting penny stock traders to invest in the company because it is due for a breakout.
If successful, this effort convinces many traders to buy up the stock. The increased demand will cause the share price to go up. The first trader then sells his or her shares all at once for a profit. The sudden sale of so many shares, however, sinks the price of the stock and the investors who came in later all lose money.
Tread Carefully Here
Penny stock trading can be lucrative but it is not easy. While some stocks may break out and bring you a profit, others will completely fold and take your investment with them. You should be prepared to take some losses before you make any gains in this type of investment.