What are penny stocks? This a very popular question asked by many people who are new to the world of investing and day trading. The answer to the question is not always straightforward, or honest. Some people will say that penny stocks are the best means by which people can get rich, whilst other will say that penny stocks shouldn’t be touched with a barge pole. The truth, as always, is somewhere in between.
The first thing young day traders and investors should realize is that penny stocks are really only stocks of listed public companies that are priced at the lower levels. As a matter of fact, the institution that regulates trading on the US stock exchange has a definition for what constitutes a penny stock. According to the SEC, penny stocks are deemed so when they trade below $5. There is more to it than that of course, but understanding this fundamental aspect of pricing is key to understanding penny stocks.
In analyzing further the ins and outs of penny stocks, it is important to note that these kinds of stocks are not only available on the Over the Counter Markets (OTC). It is not uncommon for a NASDAQ listed company to fall below certain levels, often hitting $4 or $3, and then triggering the label of a penny stocks. In a way, most companies can at one point are another, become a penny stocks.
Another important aspect of penny stocks that doesn’t get talked about in certain forums is the risk associated with trading them. Penny stocks can be extremely volatile. One day you could be examining a stock trading at say $0.10 only to find the next day that the same stock has risen to $1. These types of swings are not uncommon; these wild swings help to explain the inherent volatility with penny stocks.
The downside to penny stocks and all that volatility is that when they do crumble, it takes a strong pocket to recover. Similar to the big leap outlined above, a penny stock can end up sending gains earned deep into reversal territory. When penny stocks decline the numbers can be truly awful. It’s not uncommon for a penny stock to drop 800% in a matter of minutes. This brings up the issue of risk.
The truth is that penny stocks are inherently risky. Anyone who tries to convince you otherwise is either lying or trying to sell you something. Penny stocks can be so risky that often it is advised that they only be engaged in by young people. This has been suggested for two reasons. The first is that young people who are just starting out tend to less risk averse than older people. In the latter, there is worry that capital will be lost and nest eggs destroyed.
This is seldom the case with optimistic young people. The second reason that young people are typically matched with penny stocks is that a lot of young people have long term goals that they set for themselves quite early. So as an example, a young 21 year old with some cash to spare could invest in a penny stock and look for a longer term payoff. In many respects this is the quintessential investment strategy for people who understand the long term game.
A well-researched penny stock that is taken up in year one at a cheap price and held onto for say 6 years, could yield massive returns should a company grow into its potential. This makes penny stocks ideal for young people with solid long term investment plans.