What are Penny Stocks?
-Penny stocks are the stocks of companies 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').
Most often, the relatively low market cap that penny stocks have is due to a low price per share (PPS for short). Since it is a "small" market capitalization, penny stocks are also referred to as 'Small-Caps'. The price of a small-cap stock can have a wide range, therefore, depending on the outstanding shares. However, many small-caps have prices that can be measured in pennies, hence the name 'Penny Stock'.
There are even 'Sub-Penny' stocks, that trade as low as .0001 dollars (one one-hundredth of a penny!). A stock that trades at .0009 or less is referred to as a "trip-zero" penny stock (click the link for much more info on trading trip-zero's). Stocks that are priced this low are often referred to as 'Micro-Cap' or 'Nano-Cap', with market caps of less than 250 and 50 million dollars respectively. This isn't to say that all micro/nano-caps have share prices in the sub-penny, or penny range, however. There are many micro and nano-cap stocks that trade in the dollar range. These terms are typically used very loosely.
Why should I trade penny stocks?
-Trading penny stocks, while inherently risky, has a unique and exciting quality. Penny stocks are the fast movers of the stock market. While large stocks such as IBM and Microsoft lumber along like the giants that they are, penny stocks often race around like Ferraris. Think of it this way, for you to double your money in a $30 stock, it must go all the way to $60. To double that same money in a stock that is $.01, it must only gain one cent to get to $.02...
Now, let's think of this in terms of 'market cap', the market valuation of the company. For comparisons sake, lets say both stocks have 100 million 'outstanding shares'. If the $30 company doubles, its market value rises by 3 billion dollars! For the $.01 company to double, its market value must only rise by $100,000. Essentially, the expensive stock requires much much more money input, or buying, for the price to move. This is why penny stocks can move so quickly, and make you a profit in very little time.
Looking below, you can see how a penny stock and a large blue chip stock are compared. Think of the depth of the liquid as price, and the volume of the liquid as the market cap. The market cap is virtually related to money input (buying of shares). The penny stock with the small market cap, requires very little money, or "liquid", to create a change in the price, or "depth". Where as the huge blue chip stock takes much much more money input.
Price action vs. Market cap
What else makes trading penny stocks different?
-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 'OTCBB' exchange (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.
Penny Stock Risk Factors
Penny Stock Red Flag Checklist - A comprehensive checklist to identify hazards to your penny stock plays. Check it out and bookmark it for future reference!
Naked Shorting - A great explanation of naked shorting and the corruption of the stock market.
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.
-Now that you have an understanding of "Penny Stocks" and their unique characteristics, now you should check out the next page about penny stock company actions. Understanding these will play a key role in what penny stock you choose to invest in.