As a beginner, if you were to ever ask an experienced investor about their honest opinion regarding your intent to join the penny stock trade — and if they were to tell you the truth — their most likely answer would begin with “Don’t…” The fact is, even experts who make millions yearly from penny trading do not feel so comfortable about the venture. It is not only risky but it also requires a lot of effort and awareness to keep afloat. With the slightest mistake, every wealth that you have accumulated your whole life can tumble down to nothing.
What does penny trading mean?
Different financial institutions give different meaning to penny stocks. The standard reference, however, is that which has been adopted by Securities Exchange Commission (SEC); it defines a penny stock as any stock that trades at $5 or less per share. These shares are usually traded over the counter or on pink sheets.
While companies as well as brokers that trade large shares on the penny market have to reveal their records to SEC, the disclosure requirements are not as tight as that of the mainstream market.
In other words, regulation of the penny market is weaker compared to the main exchange market, and this provides an opportunity for rogue individuals to operate here unnoticed. In the event that you fall to the tricks of these con artists, you lose a lot.
On the other hand, if you work with the right people and follow the penny market indicators closely, you stand a chance of earning high returns faster than a person who has invested in the main market.
Benefits of penny trading
This level of trading has a few benefits that make it desirable. Below are other advantages of penny stocks:
Low Capital Requirements
To start trading in pennies, you don’t need much money. With as little as $250, you could start a thriving online business and build on it by reinvesting acquired profit. Opening a penny stocks account with online brokerage firms is usually free. Most of the legitimate firms also provide free and comprehensive training, so that you get into the trade when you actually know what you are doing.
If the wind moves in your direction, the percentage profit per share that you could acquire with penny stocks are very high compared to what you would make in the main market. Most of the times, the bid- ask spreads, happen by ten percent and above.
Overnight, you can make a lot of cash through this trade. This is different from the main exchange market where things tend to be rather stagnant.
Ease of Purchase
Purchasing penny stocks is easier than buying shares in the main markets. This is partly because the price per unit in the former is smaller as compared to the latter, and also partly because many high value shareholders are rarely willing to part with their shareholdings reason being, they anticipate higher prices in the future.
The transaction process when acquiring or selling highly priced shares involves comparatively more bureaucracies and costs, as one has to cover for the standard transaction fees levied by concerned financial institutions, and fill a lot of forms. In the lower market, due to high competition among the large number of sellers and buyers, it has fewer costs and paperwork, since players strive to out compete one another in attracting buyers or sellers.
Disadvantages of penny stocks
As pointed out earlier, the weaker regulation of this environment is the biggest threat as it allows con-men to steal from unsuspecting traders and get away with it. Recently however, the SEC has tightened its grip and has sued many collar criminals, thereby reducing the trend that was threatening to get out of hand a decade ago. Notwithstanding these efforts, malicious individuals still find this market a safe haven.
Even without cheating, the penny stocks market is still dangerous due to its volatility. The more you invest, the higher the risks you bear. You might lose everything overnight.
In essence, there is very little difference between penny stock trading and gambling. On one hand, both carry high risks; on the other hand, when you happen to reap from them, you reap big.
Even those people who have enough cash to invest in the mainstream exchange markets, they still find themselves throwing glimpses at the penny market. In the recent years, many “high level” investors have actually moved to this “low place”, and this is evidenced by the fact that small cap, micro cap, and nano cap stocks take 17%, 18%, and 18% of total trade volumes respectively. (http://www.investopedia.com/articles/analyst/010502.asp).
And the reason for this shift is quite obvious: trading with little money allows one to expand their investment portfolio as well as to spread risks. Assume you put a few pennies in company A and distribute your other investments in companies B, C, and D. If C fails, at least you still have the chance to recover from A, B, and D.
So, are you willing to take the risk? If yes, here are a few tips to keep you on the right track:
1. Trust no one
If you got an unsolicited email or phone call from someone advising you to take advantage of a particular penny trade opportunity, do not attempt to go ahead. To invest here, one news source is not enough, and particularly if that source seems to be too convincing.
Instead, before you choose where to put your money, do a wide research. Consult with various news platforms; but ensure that you avoid the reference links sent to you in unsolicited emails- most of the times it is a single individual running all those domains.
2. Don’t get emotional
A few newcomers have this tendency to get attached to their shares. They want to “help” a company grow and so hold on to their stocks despite the warning bells. The concept of loyalty has no place in the stock market; when it is time to sell, let go.
3. Emphasize on track record
As much as you can, avoid companies whose records are not clear. Some of the people that were imprisoned or fined for fraud during the 2000 dot com bubble are now sure that their names have been forgotten, and are increasingly resurfacing, this time with bigger brand names.
Experts recommend that you only go for firms that have been trading highs for the past 52 weeks. Moreover, do not let the so called “nonprofit investment advisers” convince you that they have your best interest at heart. Everybody is here for themselves.
4. Don’t expect too much
It is wise to set a moderate profit expectation and stick to it. When the market flows your way, execute and walk away. At the same time, set a particular loss limit, such that when things go downhill, you act quickly once they reach this point. The market is stronger than you; don’t ever think that you have the power to change its course.
It is estimated that over 99 percent of penny stocks ultimately die. Therefore, be true to yourself when you venture into this market and know that the risks are real. If you have to try your luck, don’t stick your head inside for too long.