Penny Stocks Trading Basics

Penny Stock Trading brings different things to mind for different people. Some immediately think of Penny Stock trading as very risky and only for gamblers. Others think it is the only way to make a lot of money quickly.

Both theories represent extremes of the factual and psychological spectrum. As you may understand, any type of trading is only as risky as we allow it to be. If we are a successful trader, we know how to control our risk at all times. We have the power to determine the amount of money used for every position as well as which stocks to pick and when to get out. There are of course other variables, some not in our control, but for the most part we have the power to make choices which can control, and/or limit our risk.

As far as the only way to make a lot of money – trading penny stocks requires the same investment of time and consideration to make a fortune, as any other strategy of the stock market trading. Miracles happen, but you need to work hard to get at the right spot in the right time.

What is Penny Stock Trading?
The definition on what stocks are considered Penny Stocks vary from one person to the next, and one website to the next. For example, the U.S. Securities and Exchange Commission states "the term 'Penny Stock' generally refers to low-priced (below $5.00), speculative securities of very small companies.

On the other hand, many traders refer to stocks priced below $1.00 as Penny Stocks while others will refer to stocks priced under $10.00.

Overall, Penny Stock trading involves low priced securities of companies with a small market capitalization. Penny stocks are stocks from a company with a 'market capitalization' or market cap, of less than $1 billion. A company's market cap is a measure of its total market value. It is determined simply by multiplying the price of a share of stock by the total number of shares out in the market ('outstanding shares'). There are even 'Sub-Penny' stocks, that trade as low as .0001 dollars. Such stocks are often referred to as 'Micro-Cap' or 'Nano-Cap', with market caps of less than 250 and 50 million dollars respectively. These terms are typically used very loosely, however.

One of the major differences between trading a penny stock and a 'blue chip', for example, is the amount of - and ability to find - information on them. For the most part, penny stocks trade on either the OTC Bulletin Board (over the counter bulletin board) or on what is called the Pink Sheets. Pink sheet stocks have no reporting requirements, and are often a small company's first attempt at being publicly owned. OTC stocks do have requirements, but they are not as intense as stocks listed on major exchanges. With less information available, penny stocks easily become valued based on pure market speculation and can be easily influenced by internal and external forces. For example: The company itself could be a complete scam. The stock could be under promotion by a paid service in an effort to increase investor interest. Groups of traders could be working together to convince others to buy, while they sell into the resulting rise. The 'Market Makers' (professionals that act as buyers and sellers to maintain an orderly market) can also easily manipulate the price of a stock to a fairly drastic degree.

So, while penny stocks do offer the potential to rise 100%, 200%, or even 1000% in a short period of time, they also carry with them some big risk factors. To be successful trading them, you must find the stocks that have the best potential, fewest number of "red flags", and have a strategy that will let you lock in solid profits and reduce risk. Check out the links below for more information on stock scams and the corruption in the stock market.

Some of the Risks with Penny Stock Trading
  • Lack of volume in publicly traded shares.
    Although you may see a large number of shares being traded, due to the low price, many of these shares may be a small number of traders. In this case, once you are in a position, it may be hard to get out. A way to help minimize this risk is to search for a minimum number of shares being traded to fit your needs.
  • Pump and Dump
    This is common for low priced stocks due to the lack of regulation and enforcement of Penny Stocks. Many "Stock Promoters" are paid to send out mass mailings and emails, "Pumping" up the hype around a particular stock. Just like any other investment you make, due your own research before making any final decisions.
  • Lack of Financial reporting requirements.
    Many low priced small cap stocks are not required to file the same financial documents as larger companies, therefore it makes it harder to take a look at the numbers behind the company.

Rewards of Penny Stock Trading
Rewards. Yes, there can be rewards also. I'm sure you've heard about them at one time or another. Take a stock priced at .20 that trends higher over a few weeks or months and is now trading at $2.00, or better yet, how about $5.00. Or a stock trading at $2.00 that moves up to $10.00. You can find them, and they are out there.
On the other hand, since you now know that a "Pump and Dump" can happen, you can short a stock that has moved up too quickly, too fast, for no good reason and profit from it's downfall.

In order to be around to profit from these moves you must have a trading plan in place that works and stick to your rules at all times.

Is penny stock trading right for me?
If there is one sure thing about penny stocks, it is that penny stocks aren't for everyone. If you are only looking for a safe, solid investment that will slowly grow in value over years, penny stocks are not for you. If you think of penny stock trading as a form of gambling, you may win a few profits, but in the long run you will probably not succeed. Penny stocks, like any investment, demand discipline and patience. On the other hand, if you have money you can afford to lose, penny stocks are an exciting form of investment that can possibly earn a large return in a short amount of time.

To increase your chances of gaining wealth with penny stocks, you must increase your level of knowledge. This is why this site can help you succeed. With the right basic stock market knowledge, you are starting off on the right foot. Learning how to trade stocks is like learning a new language, not many people can do that without hard work and studying.

Often, experienced traders will diversify and utilize a portion of their capital to trade penny stocks. This way they have solid, long term investments to protect the majority of their money as well as penny stocks to provide the chance for large, quick gains. For most beginners, this isn't possible, but it is a suggestion for allocating future gains that a successful penny stock trader may earn.

If you want to make money, you have to be able to buy and sell enough shares to lock in your profit, or protect your capital. If ABC company's daily volume is only 500 shares a day, it may take you several days to accumulate a position worth taking. If there is bad news, who is going to buy your shares? If the volume is low, stay away. Its not worth it. If you feel that strongly about owning the company, consider contacting the company directly and working out a deal.

Buy Results, Not the Story
If you buy the hype, odds are, you will end up being the last one to own the shares, while everyone else has sold off their position. Look at a company, take a look at what their business plan was, and confirm if they have followed through on that plan. Were they successful? Did they bring a product to market on time? Did the company follow through on its acquisition strategy in the manner they set out? The hype might get you a quick pop, however, unless you are watching your trading screen every second of the trading day, you will miss out.

Size matters
There are thousands upon thousands of penny stocks. The size of your position should not be anymore than $2000 - $3000. While this may not seem like much, keep in mind that its not unusual for a $0.10 company to drop to $0.05. That's a 50% loss. If your position is $10 000, a 50% haircut leaves you with only $5000. Keep your losses to a minimum. If the company has done well, and you are up, either take your profits off the table, or add to your position, and be sure to reset your stop loss so as to protect your previous profits. Capital preservation is the key to successful trading.

Have a plan before you buy. What are your reasons for buying? What is your exit strategy? Where is your stop loss? At what point will you take your profit? Write down these answers before you place that buy order.

Sources and Additional Information:

Related Posts Plugin for WordPress, Blogger...

3-column blogger templates(available in 4 different styles)