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The Benefits and Pitfalls of Penny Stock Trading

Table of Contents

What Are Penny Stocks?

Penny stocks or “Micro-cap stocks” are terms used to label regular common stock that trades at five dollars or less. These five dollar stocks are traded OTC (Over-the-Counter). They are not traded on the traditional major markets such as the NYSE, AMEX, or NASDAQ. They are often found on the OTC bulletin board.

Benefits Of Penny Stocks

The main advantage of penny stocks is that they have a very low barrier of entry. Often these stocks are chosen by beginning investors as a practice ground before moving on to the major markets. Even though this market has lower-cost, they still have great potential for gains. You can, in theory, double your money overnight. These stocks are a great way to hone your skills as a trader without putting a large amount of money on the line.

You can be in the markets developing real strategies rather than practicing on paper.

Penny stocks are easy to buy and listed in each of the stock exchange markets readily available for the public to view. Just as with all other stocks, you should do your homework, beware of hype, conjecture, and analyze volatility.

Risk Of Penny Stocks

Penny stocks are not without risk. Something to consider is that the SEC does not register penny stocks. The reason why is generally because it is a fledgling company just starting. If you invest your money into one of these companies and the company violates some law or goes under, you could lose all your money. Penny stocks can be mostly unregulated, which makes it a prime breeding ground for unethical activity.

Lack Of Transparency

A major pitfall is the lack of statistics and information. Penny stocks are either companies that are just starting with no consistent history, or they are companies that are on their way to the point of bankruptcy. Newer companies can be extremely volatile, depending on the industry and management. One week the company might be doing exceptionally well and then the next struggling to stay afloat. Because of this, penny stocks can be very unpredictable and risky for the average investor.

Warning: Be careful of fellow investors trying to unload their many shares of penny stocks or any other type of stock. E-mails that sound too good to be true usually are so please beware.

Lack Of Liquidity

The market of penny stocks may be large enough to trade, but liquidity can be your enemy or the lack thereof. There are times that once you have bought shares in a company, for some reason or another, you want to liquidate them ASAP. In the normal major markets, this may not be a problem, but for the penny stock market, the lack of liquidity can be an extreme variable. Sometimes it may be difficult to liquidate your position when you decide to sell or get rid of your shares. If there is a quick turn against your investment, you may not have any choice but to ride the trend to the end of the line, no matter what the outcome. The wisdom it takes to navigate this type of variable is usually found in more experienced traders, but the allure of quick money draws new and old traders alike. All the pitfalls stated thus far relate to an environment geared toward an experienced investor and not for the average investor. But because of the low cost of these stocks, inexperienced traders flock to this market.

Avoiding Common Trading Mistakes

Beginning traders often make the same common mistakes. Avoiding the common mistakes can be your first step toward becoming a successful trader. One mistake is to blindly follow advice from an expert, newsletter, or website. No one is 100%, 90%, or even 80% correct all the time. Nobody can even consistently pull 50%, 40%, or 30% year in and year out. If you are serious about becoming a trader, learn, study, practice, and develop your strategy.

Discipline

Another common rookie mistake is “jumping in” when it is unnecessary. The average trader may want to try out a new strategy without first doing their due diligence or testing. Usually, they often feel that they have control over their system and are ready to push it to the limits. They go for the big bucks and end up taking a bath all because they had to be “In” the market. Making money in the markets can be highly addictive, and with all addictions come an unbalancing of judgment. Using your gut, feeling lucky, or any phrases like these can kill your portfolio quickly. Some of the best traders are ex-military personnel. Military personnel train to follow discipline. Disciplining yourself and doing what needs to be done is the core of military training and curriculum. This training is an ideal way to approach trading the stock market. Following a set of rules and sticking to those rules within a structure, is what makes some traders world-renowned.

Conclusion

Overall, penny stocks can be a wild ride. If you can handle the ups and downs, this could be a profitable investment of your time. They are an affordable investment with excellent upside potential. Technology can also be a great asset nowadays, as the stockbroker is slowly becoming obsolete. More data is available now than ever before. Software used to create trading strategies is within reach of most consumers. It doesn’t matter how old you are. Anyone willing to learn can excel and make money. Even if you are older, you can learn and make money well into your retirement.

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