What are Penny Stocks?

Penny Stock are Small!
Stocks are defined by their market capitalisation (number of shares in issue multiplied by the value of each share). A company with 1 million shares at $100 dollars per share has a market capitalisation of $100 million.

Learn to trade for $4.95

Listed companies are divided into groups according to size. Large Caps are the top end of the spectrum (the Google's of the world), then the Mid Caps and the Small Caps. At the bottom end you have the Micro Cap firms which will generally have less shares in issue at a lower price per share (ie. Lower market capitalisation). Penny Stocks fall into this category and generally defined as being less than $5 per share.

It is important to know that this is a relatively ‘lose’ definition because even a large company could potentially trade for less than $5 but would not be classed as a Penny Share (some banking stock during the credit crunch reported huge stock losses but would not be considered a penny stock).

Penny Stocks are generally too small or do not meet all the rules and regulations (perhaps due to financial constraints) to make it onto the larger exchanges (the Nasdaq, the S&P etc). Consequentally it is harder for them to raise money to invest in themselves. They do not have media exposure, they might be new and do not have the history and are just too small to attract the interest of Global Investment Banks looking for companies to absorb billions of dollars of investment funds.

Traded on the ‘Over the Counter Bulletin Board’ or through the ‘Pink Sheets’ Penny Stock are a higher risk investment than say large cap stock. To list on the OTCBB companies have to report financial statements but there are no listing requirements like those found on the NASDAQ or New York Stock Exchange. Penny stocks generally trade less frequently and have larger bid-ask prices.

The biggest secret to you trading success will be the investment it you. Check out this quality course for only $4.95 - It's highly recommended.

Why Trade Penny Stocks?

Penny Stock are Value!
As a value investor you are looking for stocks that trade for less than they are worth and generally 'undervalued' by the wider investing community (eg. You are looking for a share worth $10 trading for $5). Your job is to be one step ahead of the herd and get there first.

You see most investors are like sheep. They see a good opportunity but do not have the guts or insight to invest, so they wait, and wait, and they wait. They wait so long that by the time they have summoned up the courage to invest, the share price has already shot up and they have missed out on huge profits.

They follow the herd but as a value investor you are going to find that company first and get in there before anyone else (while the share price is low) and the company still unloved and undervalued. Once the herd start to follow, it's your turn to start planning your exit and when to sell so that you can make as much money as possible and banking your profits for the next venture.

The amazing Warren Buffett favourite holding time (ie. How long you keep a share) is forever. Mr Buffett, a truly legendary investor believes in find good quality stock, a sound company that is going to stand the test of time. You should never have to sell a good holding. In an ideal world, we should all be acting like football scouts for that next big idea that will make a company a global success.

In reality (and I hate to be pessimistic) it is very unlikely that you will find the next Google, Microsoft or Apple amongst the OTCBB listings. With so little information available (and the difficulty distinguishing fact from fiction), finding those rising stars is tough and usually they will not even go to the OTCBB to raise capital. This isn’t all bad news. In fact it means you can look to profit in a much shorter space of time, take your profits and run, perhaps within the space of a couple of hours.

As a penny stock investor it is your job to identify the trends that will catapult your target stock price upwards. You exercise caution to make sure you are right and the odds are in your favour, analyse the trends and buy in for as little as possible. Now you watch and wait, planning your exit. So many people focus on the ‘buying’ of stock when it is the ‘selling’ of stock that will make or break you. Identifying an exit strategy is key component of any trader (and well covered in the Trading Master Plan).

Within the space of hours or days it is possible to double and triple your money and this is the key attraction to Penny Stocks. With a $1000 you might buy nearly 100 stock of a globally successful company and they are very unlikely to double. A $1000 spent on penny stock goes a lot further and it is much more realistic for a smaller company trading at $0.50 to double in value. That is why we trade penny stock.

This video will show the fundamental skills behind finding great stock

Pump & Dump - Penny Stock Scams

Supply, Demand and Market Sentiment:
All stocks are traded on prices determined by ‘supply and demand’. In an ideal world, quality stocks would be in greater demand and trade at a higher price than lower quality stock. In reality, stocks are subject to market sentiment, rumours, media attention or even the words of a well respected, seasoned investor. This can have positive or negative consequences for the stock price.

The Pump:
Exactly that, stock prices are pumped up to unrealistic highs. It could be rumours of a new contract or profits, a newspaper column with a gleeming 'buy' recommendation or just lies that spread the investment world. Consequentally, all markets and all stock are at risk and subject to false information, spread deliberately to manipulate share prices. Why someone want to do such a thing? Easy, to make money.

One of the most common forms of market manipulation that affects Penny Stock is called ‘Pump and Dump’ an illegal activity with underhand tactics. Here’s how it works…

Leaked information and rumours start to spill across the internet, newsletters, email inboxes and forums receive a trickle of information that Company A is a ‘hot penny stock’. Glowing reports on its financial status, that it has cracked a new market and its prospects are bright start to spread. It might feature in the newspaper, on the television or an analyst might recommend it.

Investors start to pump their money into the company pushing share prices up as the supply dwindles and demand goes up. The stock price is slowly pushed up to higher and higher prices, they are Pumped Up, all on the basis of false or hyped information.

The Dump:
With shares trading at a premium, the fraudsters sell their holdings as the share price peaks, making a killing on the shares they originally bought for next to nothing. With no solid fundamentals or reason for the stocks to trade so highly the share prices falls back to realistic levels. The investors have paid a premium for a share worth next to nothing.

The final kick comes from the fact that, in this smaller market these stocks are less ‘liquid’. Unwanted and unloved the stock holders have little change of selling the stock on and are left holding them. They have essentially lost all their money.

How Big is the Scam?
The Financial Services Authority estimates that losses at £200 million per year (close to $4 million) in the UK alone. This scam is global and with so much money involved, industry spokesman believe it impossible to eradicate.

Avoid Pump and Dump Scams:

1) The Source
Who and what is the source of information. Any spam email are likely to be Pump and Dump scams. And because you do not contact the person who sends the email (you buy the stock yourself however you normally trade) the scams are hard to trace and shut down. If a broker you do not know or from an offshore location, ask yourself why they are promoting it.

2) Find out Where the Stock is Traded:
Penny Stock and Micro Caps are not traded on any major exchange. As a result, the rules and regulations around the company and the information they disclose is often limited and hard to come by. If the stock is traded on the Pink Sheets or on the OTCBB (Over the Counter Bulletin Board), then chances are it is a Penny Stock.

3) Do your homework:
Any rumours you hear or any offers to buy stock should be checked independently with your own research or through a broker you already know and trust. Carry out some fundamental and/or technical analysis on the stock. Look at media reports (always questioning the source) and see if you can verify the claims.

4) Watch for Boiler Room tactics:
Featured in the Vin Diesel film ‘Boiler Room’ – these high pressure sales tactics usually revolve around persistence and creating a ‘boiler room’ feeling. Any broker who is pushing for you to buy before the ‘opportunity of a lifetime’ passes is likely to be a part of a ‘Pump and Dump’ scam.

Remember there will always be another opportunity. Use your gut instinct, if something doesn’t feel right, it usually isn’t. This course is high recommended and has great video showing you what you'll learn.