The U.S. Securities and Exchange Commission (SEC) defines a penny stock as a stock that trades under $5 per share. Penny stocks get a bad reputation, and many investors automatically think of shady companies or pump and dumps. However, it’s not a good idea to assume that all penny stocks are bad and not worthwhile. There are penny stocks that trade on the NYSE and Nasdaq, which have strict listing requirements. Consequently, these penny stocks are more transparent, unlike those traded on the Over-The-Counter bulletin board (OTCBB).
For example, to be listed on Nasdaq, companies must have a minimum of 1.25 million publicly-traded shares upon listing, excluding those held by insiders. Additionally, the regular bid price when a company is listed on Nasdaq must be at least $4 and there must be at least three market makers for the stock. Moreover, stocks traded on the NYSE or Nasdaq must maintain standards set out by the exchanges to continue trading.
Liquidity
Although penny stocks listed on the NYSE and Nasdaq trade like blue chip stocks, there are some risks inherent to pennies that you should take into account. Since penny stocks are typically micro- and nano-cap companies, there is usually low average daily trading volumes in them. Many investors are more focused on small-, mid-, large- and mega-cap stocks, and consequently, micro- and nano-cap stocks are taken out the picture.
Moreover, since penny stocks have lower liquidity, they have wider bid-ask spreads. Now, if you’re short-term trading, this could be a problem. If you understand the risks and want to invest in penny stocks, it’s always a good idea to use penny stock alerts. However, if you’re investing in penny stocks and have a high-risk tolerance, the wider bid-ask spreads shouldn’t worry you too much.
Now, you just need to make sure you’re trading the “best” penny stocks, which are transparent and have a higher degree of liquidity than others. Additionally, you’ll need to keep in mind the risks involved with pennies before investing or trading.
There’s A High Potential Payoff in Pennies
After all, successful companies aren’t born, they’re built from the ground up. For example, if you look at Apple’s stock price on an adjusted basis, it was a penny stock for quite some time and trading below $1. However, it’s currently trading above $110 per share at the time of this writing. So if you’re looking for high returns, you could scour through penny stocks listed on the NYSE or Nasdaq to find the best potential investment candidate.
Looking into NYSE or Nasdaq stocks gives you an idea of the fundamentals of a company. Since stocks listed on these major exchanges require financial reporting, there’s more transparency and you’ll be able to see whether the company is growing or not. If you’re early and have an edge, you could capitalize on the potential embedded into penny stocks.
Volatility
Now, penny stocks also get a bad reputation for experiencing high volatility. However, volatility does not necessarily mean that penny stocks will fall in value, they could easily spike up 25%…but they could also fall 25%. If you look at how a penny stock has traded, you can get an idea of how they could trade and what price levels to look at. You should also keep an eye out on news and the short interest on penny stocks. For example, if there’s positive news and a high short interest on a penny stock, there could be a short squeeze and the stock could spike up.
Example of Meteoric Rise in a Penny Stock
If you’ve been following the markets closely, you’ve probably heard about DryShips Inc. (NASDAQ: DRYS). The stock went from below $5 per share to just above $100 per share in a matter of days. This was primarily due to its proposed debt restructuring and the increase in the Baltic Dry Index, which indicated that there could be a higher demand for shipping. Now, if you set an alert for this stock and got in early and took profits, you could’ve realized over a 100% return. However, as stated earlier, penny stocks could go either way.
Take a look at the chart of DryShips provided by TradingView below. DryShips spiked up by over 2,000% in just five trading sessions. However, shortly after, it fell back to where it came from. When trading penny stocks that experience moves like this, you should always have a target exit price and not hold on too long.
The Bottom Line
Not all penny stocks are shady, if you’re looking in the right place. You should stick to those that trade on the NYSE and Nasdaq, and do your own due diligence. Penny stocks have a high potential payoff, but they do carry a high degree of risk and could fall in value, after experiencing a meteoric rise. Therefore, you should trade penny stocks that have a higher degree of liquidity, relative to other pennies. Moreover, you should set alerts for pennies to potentially realize high rewards.
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