Common Questions For Penny Stock Trading

Common Questions For Penny Stock Trading

If you are new to penny stock trading there are normally a number of questions that you need answered before beginning to trade. This article will attempt to anticipate such questions and provide answers for them. Many of these questions and answers could be applied to trading stocks in general, they are not necessarily only for penny stock traders.

What is the Definition of a Penny Stock?

The SEC (Security and Exchange Commission) has put to rest the confusion over the definition of a penny stock. They have said that a penny stock is any company that is trading at less than $5 per share. Some in the past have tried to define a penny stock as only those stocks that trade less than $1 per share while others have mistakenly understood them to only be companies that are trading at a price of less than one penny.

There is no other criteria that is necessary. There is no volume component or earnings component to the definition of a penny stock. Very simply stated, if it is trading at less than $5 per share then it is a penny stock.

Where Do Penny Stocks Trade?

Penny stocks can trade on any exchange. Having said that a great portion of them what on what is known as the Pink Sheets and the Over-the-Counter Bulletin Board (OTCBB). The reason that this is the case is because the New York Stock Exchange (NYSE), the Nasdaq Stock Exchange and the American Stock Exchange (AMEX) have what is known as listing requirements. Some of the listing requirements are that the companies need to adhere to a certain type of accounting method that gives the investor more clarity as to the financial position of the company. Other requirements are the size of the company in capital and a minimum number of days that the stock is allowed to trade below a certain share price. That share price is not set at $5 per share, however. For most exchanges, it is somewhere around $2 per share.

So there are NYSE penny stocks, Nasdaq penny stocks and AMEX penny stocks. You can scan any of the exchanges and find dozens if not hundreds of penny stocks on each exchange. Those that are not listed on the exchanges will be found on the Pink Sheets and OTCBB.

Are Penny Stocks Safe to Trade?

If you are asking this question, you should be aware that all stock trading contains risk. You can lose some or all of your money that you have chosen to invest. That being said penny stocks are more volatile that the average stock. Some of them would also be at a greater risk of bankruptcy than the average stock as well. I don’t want to underplay the risk of penny stocks but a few things need to be pointed out. The first is that with an appropriate penny stock trading strategy the risk of trading can be mitigated to a great degree. We will touch on this briefly in a later question. The second point is that it is not as if the average penny stock is on the verge of going bankrupt tomorrow. Now if you spend much time on the penny stock message boards you might come to this conclusion, however, that is just not the case. Most of these companies give enough visibility to their earnings and the rate at which they burn through cash for you to make an informed decision to either invest or to stay away.

What is the Difference Between Penny Stock Investing and Penny Stock Trading?

Generally, the difference is time horizon. If you are going to invest in penny stocks you are thought to be buying a company and hanging on for months or even years. You believe in the prospects of the company that you have purchased and think that it is a long term hold. If you are trading penny stocks then you are only hoping for a quick move to make money on your trade. If you can get your desired profit in one day then you will close the trade and move on to other opportunities.

Now I must interject an opinion at this point. I do not believe that the average penny stock is suitable for long term investing. I think they are spectacular trading vehicles but are not proper to buy and hold in hopes that they will greatly appreciate in price. Remember that penny stocks trade below $5 for a reason. Either they have a poor business model or they don’t have enough cash or they face tremendous market competition or they have poor management or they have a product that no one wants. I could go on but I think you get the picture. These are not your bastions of the investing world. Don’t try to pick the next Microsoft. Just trade the companies and be done with them.

Are There Certain Penny Stocks That I Should Avoid?

You will have to determine what penny stocks you are willing to trade. This threshold is different depending on who you are and what your risk level is. Personally, I avoid penny stocks that do not trade at least 300,000 shares on average each day. Others may set that figure at 1 million while some may not have a lower limit. The reason that I choose 300,000 is because I don’t want my movement in and out of the stock to affect the pricing of the penny stock. If I attempt to sell 3000 shares of a company that only trades 20,000 shares per day then my one sale is more than one seventh of all of the trading done that day. This will most likely depress the stock price a bit and cost me money on the way out of the position.

I also find that the spread (difference between the bid and the ask) is usually only one penny on stocks that trade at least 300,000 shares per day. I prefer a tight spread.

Another criteria that I use is to only trade penny stocks that exceed 50 cents in price. Rarely do I ever trade anything that is below $1 but I never trade anything below 50 cents. The sweet spot that I tend to focus on is between $1 and $3 per share. I find that I get the best price movement in these ranges.

I never trade a penny stock that is in bankruptcy and never trade one that is generating a lot of questions about its ability to continue as a going concern. I want to know that the company is not going under while I am holding it. I prefer to trade companies with a decent cash position but at the very least something that indicates to you that they will be around for at least a few weeks longer.

Can You Short Penny Stocks?

Yes, you can short penny stocks. However, depending on which penny stock broker that you are using you may or may not be able to come up with shares to short. There are a few individuals that make a killing by shorting penny stocks. Tim Sykes would be one of these individuals. When you think about it, it only makes sense. Penny stocks trade at the level they do for a variety of reasons. When they spike upward in price there is a greater than average chance that they will once again drop in price. It only makes sense to take advantage of that and short them.
If you going to make a practice of shorting penny stocks then you might want to select a penny stock broker that is more adept at finding shares to short. This is difficult for many different penny stocks. Some brokers just do it better.

Should I Subscribe to a Penny Stock Newsletter?

There are a few penny stock newsletters out there that might be worth your time but the majority of them are nothing more than paid promoters for the company. I believe that you are always best to make your own trading decisions. Penny stock newsletters have a way of buying the stock before they issue the alert to their subscribers and then exit the stock as their subscribers are buying. The only ones left holding the bag are the people that subscribed to the service. You need to make you own decision here but I would avoid them if you can.

Well, hopefully this answered some of your questions about penny stock trading. I am sure that you have many more. Stop by in the future and I am sure those questions will be addressed at some point.