Last week in our Core Foundations to Profitable Trading class we met a lot of people who came from all walks of life. We noticed a lot of them started out in penny stocks and said they didn’t have much success. I can see how this could arise so I wanted to discuss what is penny stock investing and things to consider before making your first trade.
What is Penny Stock Trading?
There are countless YT videos and online articles that go through penny stock investing for beginners so we won’t add to much what can be already googled. Penny stock investing is buying or shorting (betting on a fall in price) of stocks that trade up to $5. They appeal to many especially to those who don’t have a lot of money to trade where they can control a lot of shares and even utilize margin in certain instances. People usually gravitate to penny stock investing when they first learn to trade for the reasons mentioned above but also for the fact it can be touted as a quick way to become rich if the stock takes off.
- Control a lot of shares with small accounts
- Make quick trading profits over a very short time span sometimes in minutes if the stock soars or crashes on thin volume.
- Ummm, That’s about it
- Thinly traded where you can be stuck in a position for weeks or months (see chart below) if there is no volatility
- Only 3 real ways to make sizeable profits for the risk. Acquisition/announcement, company goes bankrupt, or a pump and dump scheme happens within minutes or a few days tops.
- Stock manipulation can and does occur frequently in this market from “influencers” or the company’s brass.
- Hard to borrow shares in shorting penny stocks.
Let’s briefly look at a typical stock chart of a penny stock. and discuss how people make money but also lose money trading this asset class.
Most penny stocks have their spikes in cases called a pump-and-dump scheme. And they usually follow similar traits which leads to some getting paid a lot, and most holding the bag. A pump-and-dump in it's most simplest definition is when either a false narrative is created by the company or an influencer that something "game-changing" is taking shape or a major "approval" or "contract" is pending causing a flurry of interest and increased share activity in a particular penny stock. Usually what happens is new traders will purchase shares creating liquidity while larger block orders from say influencers or execs are offloading them now that there is actual movement and volatility in that stock.
There are practitioners out there that make money trading penny stocks I wont deny. However, for every 1 successful penny stock trader there are a dozen or more losing traders who lose money and then call it a scam. Penny stock trading is built around a community premise. What this means is because a stock has thin volume daily there needs to be a reason or "catalyst" for a dormant stock to move. In the penny stock world it follows that chart above and this usually gets buzz going.
WHAT IS THE ALTERNATIVE THEN IF YOU'RE TRADING A SMALL ACCOUNT?
It really is easy. it bodes down to the following:
- Stick to stocks that have a lot of daily volume that is trading say a few million as a base starting point
- Find stocks that have the above then look to see if its optionable (meaning you can trade options on it)
- Make sure it has a high beta compared to the index it is tied to (this means for every 1 percent move say the DOW has this particular stock moves either less percentage wise or more. A 1.0 means it moves in lockstep usually with the underlying index. Any more or less you get the picture).
- Find cheap weekly options if you can. We discuss this with all of our new students trying to grow small accounts about taking advantage of weekly options trades.
- There are a host of other things to consider but this is a good starting point for those who are reformed penny stock traders looking to trade other markets where manipulation and sitting and waiting forever no longer appeals to them.
If you want to learn how one of our students made 20K in February trading part-time while he maintained his career I encourage you to register to our webinar this Friday at 7:30pm EST. He will discuss how options trading has helped him and also provides easy liquidity for entering and exiting trades.
WEBINAR: REGISTER NOW