Whilst many traders seem to have built fortunes in record time by simply taking advantage of the huge opportunities that Penny Stock Trading can offer, other traders have instead blown their accounts while trying to do the same. It should not come as a surprise then that so many people are ready and willing to call penny stock trading a scam and others are ready to swear by it whilst standing proud.
So… which one is it then?
Is penny stock trading a scam or a legitimate way to maximize and diversify our trading portfolio?
Well… you guessed it, that is the question we’ll try and answer for you in this article.
Let’s get going!
First of all…
What is penny stock trading in the first place?
Penny stock trading is a type of speculative trading in which traders buy and sell low-priced stocks, typically under $5 per share. These stocks are frequently linked with small or new companies with low market-cap and are traded on over-the-counter (OTC) or specifically small-cap exchanges.
Penny stock traders often use a variety of tactics and strategies to profit from these low-priced stocks’ price swings. Whilst some traders concentrate on short-term market volatility, hoping to profit from short-term momentum plays or price swings. Others buy in penny stocks with the expectation that a specific stock will experience tremendous growth in the future, potentially resulting in a huge profit.
What are some of the advantages and disadvantages of penny stock trading?
These are the three main advantages of penny stock trading:
Low entry barrier
Arguably, the biggest advantage of trading penny stocks is the low barrier to entry. These stocks often cost less than $5 a share, making them accessible to investors with smaller budgets. The low cost can be attractive for aspiring traders and investors seeking to gain exposure to the stock market without significant financial commitments.
Volatility and liquidity
Penny stocks are known for their volatility, and volatility, as we all know, creates opportunities for quick price changes. If things go according to plan, the larger the price movement, the larger the profit; it’s understandable then that the penny stocks’ is many traders’ favorite market.
Potential for high returns
Penny stocks are known for being able to offer high returns on investment. Because of their low price, even a slight upward rise might result in significant percentage returns. If timed correctly, the possibility for big returns can be very very attractive to traders searching for higher profits in a shorter time.
And these are some of the disadvantages:
High risk
While the prospect of high returns is appealing to everyone, trading penny stocks comes with a higher level of risk, and that is not appealing to everyone just as much.
Penny stocks often have no track record, making them difficult and challenging to analyze and evaluate. Determining their long-term viability sometimes becomes more a matter of opinion than clear indicators. And, as if this wasn’t enough already, penny stocks are vulnerable to manipulation and fraudulent activity, offering fertile grounds for possible fraudulent behavior.
Lack of information and transparency
Due to their small market capitalization and limited following, penny stock companies often provide minimal information and transparency. Traders and investors may struggle to find accurate financial data, making it really hard for traders to make good and informed decisions. This lack of reliable information can contribute to increased risks when trading penny stocks.
Low liquidity
Penny stocks have lower trading volumes than standard stock and that, sometimes, can lead to illiquidity. The lower volume can make it difficult to buy or sell shares at the chosen time and at the target price and annoying (and at times, expensive) slippage is often the result.
Price and news manipulation
These two last points – low liquidity and limited information low-cap companies – combined make very fertile ground for fraud and manipulation.
The small price and the low level of liquidity (caused by the limited number of buyers and sellers) mean that it is possible for groups of ill-intentioned fraudsters to increase the price of stock merely by buying it in large quantities. At the same time, the lack of sufficient information makes it hard for investors and traders to establish if these price increases are justifiable by the company operations or just the results of manipulation. The less-experienced traders often rely on internet influencers and “second-hand” analysis without realizing that, many a time, fraudsters would be one step ahead and often divulge fake news and information with the intention of strengthening public confidence in the penny stock they intend to manipulate.
Many influencers have already fallen “victim” to the SEC for exactly this kind of behavior.
Once the hype is built and the penny stock reaches the desired price, the manipulators would sell the many shares in their possession for a large profit in a very short period of time. The price of that stock would consequently drop rapidly and drastically leaving genuine traders and investors “holding the bag” (virtually worthless stock).
This process is called “pump and dump” manipulation and it’s the most common type of fraud present in the penny stock market.
Here are three penny stock trading strategies you can adopt right now
Momentum Trading
Momentum trading focuses on identifying penny stocks that are experiencing significant price movements and jumping in on the trend (trying to do so before it ends).
To use this strategy, penny stock traders often look for stocks with high trading volumes and sudden increases in volume and increases or decreases in price. They aim to profit from short-term price movements by buying stocks on the upswing and selling them quickly for a profit.
Catalyst trading
Penny stock traders pay great attention to actual and potential catalysts that may drive the stock price. This can include earnings releases, corporate news, regulatory approvals, or industry developments. Timing your trades around anticipated catalysts can help you take advantage and profit from short-term price movements and fluctuations
Short selling
Short selling is by far the most used strategy when it comes to the penny stock market.
As in any market, the process of short selling consists in borrowing shares from the broker and selling them immediately hoping to be able to rebuy them later at a lower price and returning them to the lander whilst pocketing the profit.
Given that the Penny Stock market is characterized by minor companies and lower market cap, it can sometimes be easier to spot stocks destined to decline than stocks that show promise and potential; this is probably why so many traders chose short-selling as their go-to strategy when it comes to penny stock.
Keeping up with news regarding both the company and the industry in which it operates is vital for a short-seller. Penny stock companies are way more vulnerable to micro and macro changes in the economic and social environments than other stocks. Any event that could obstruct the operation of a company (such as higher oil prices, reduction in material availability, and so on) as well as a sudden and unjustified stock price increase is often taken as an indication that a price drop is about to take place. Short-sellers would then go ahead borrowing and selling shares with the intention of rebuying them later as we explained above.
It is important to note that short-selling comes with a higher degree of risk. This is because it involves borrowed money that must be repaid whether your trade is a successful one or not. Also, stock prices could theoretically rise indefinitely which means short sellers face potentially unlimited losses.
Here are 3 good tips for penny stocks trading:
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Be Thorough with your penny stock research
The most important aspect of penny stock trading is the research.
Research and analyze your pick of stocks extensively. Look for companies with solid financials, good management teams, and strong potential for future growth. Keep yourself updated with news, press releases, and industry and company developments that could affect the stock’s performance one way or the other.
It is only by conducting meticulous research, that you can identify stocks with the potential to offer your well-deserved rewards. -
Keep an eye on volume and liquidity
Keep monitoring the average daily trading volume of your penny stock of choice.
Stocks with low average volumes may experience wider bid-ask spreads, making it quite difficult to execute trades at your target price. Try to avoid illiquid stocks or you might have to hold on to them a little longer than you wish and intend. -
Stay away from stock with excessive (and dubious) promotional activity
Be wary of penny stocks that have aggressive promotional campaigns or pump-and-dump schemes. These manipulative tactics can artificially inflate stock prices, making it risky for traders who may get caught up in the hype. Critical evaluation is key here.
If only…
It seems pretty clear that penny stock trading can be a high-risk, high-reward way of doing things. While the lure of potential quick profits may be appealing, it is vital also to consider the risks associated with trading in the penny stock market.
If only there was a way to diversify our portfolio and take advantage of the huge rewards penny stocks are able to offer whilst also minimizing the risk of losing our own money at the same time…
Oh, but wait! There is!
Trade the Pool is currently the only prop firm that allows its traders to dip their fingers in the penny stock and, just as they do for standard stock, they’ll share the profit with you but they will also protect you and your finances from any loss by taking it onto themselves. So you see, traders can still get all of the potentially amazing benefits without running any unnecessary risk.
Penny Stock Trading – Conclusion
The penny stock market is characterized by low-cap companies and low-price shares. This means that the market is easy to manipulate and often it is.
However, it can hardly be called a scam. The participating companies are generally genuine and just trying to grow. With the right mindset, thorough research, a good trading strategy, and a strong partner such as Trade the Pool, it is certainly possible to take advantage of the market’s high volatility and make good good profits.
Really hope this helps.
Trade on, traders!
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