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Penny Stocks Trading: Tips to Create Wealth

By Charles Hopkins Published 03/13/2006 | Finance

Penny Stocks are often defined as stocks priced below 5. The stocks that are traded at a very low cost, for even under 1, often for under a penny, are given the name 'Penny Stock'.

It is often implied, but isnt necessarily true, that penny stocks are also micro caps with capitalization of less than about 250 million, and is therefore capable of creating vast wealth.

It is interesting to note that penny stocks are found across the full range of capitalization from micro caps to large cap stocks. For example, Sun Microsystems (NASDAQ: SUNW) met the definition of a penny stock for much of 2004, trading between 4 and 5. In late 2004, trading between 5 and 6 per share, its capitalization was over 18 billion! These are typical micro cap penny stocks.

The small investor has a clear-cut advantage over others when an early position in a good micro cap penny stock is taken by him. As a group, micro cap penny stocks are generally avoided by large funds since prices are very easily affected by sizeable buy and sell orders. Also, capitalization is too small to affect a large funds bottom line.

There are insider responsibilities involved in buying more than 10% of a publicly held company. To avoid this, large funds usually dont take up penny stocks not even the micro cap ones.

Apparently low-stake and low-load, penny stocks can be quite risky because prices move too often. That is the reason why most wise stock market investors avoid them, even when money is there to be made in this market.

High risks exist in these because of their wildly fluctuating prices. Hence the first tip to create wealth with penny stocks is: try to get into investing in these stocks if you have prudence and low tolerance limits.

You may feel especially attracted to these, since it is possible to put small money in search of high returns. In that case you must try to know the company the stocks represent carefully and extensively. And only then can you expect big money from your penny stock.

Keep away from unknown companies. Most penny stocks come from newly instituted companies which are as a matter of fact, totally unknown, so the investor has hardly any information to depend upon when attempting to make an investment decision. Sometimes behind the widespread ignorance they are of companies in very serious financial state or may be almost on the verge of bankruptcy. It is better to avoid penny stocks unless you have dependable information from insiders.

Another high-risk pitfall comes from the important difference in how penny stocks are traded. They are confined to secondary markets to the Pink Sheets, for example. There the liquidity measure of how easy it is to buy and sell a stock is much lower than they are in the majors.

Given the low per-share price, it is not unusual for individuals to hold hundreds of thousands of shares. Frequently the liquidity evaporates soon, making it impossible to exit such large positions without severely dragging the share price further down.

So if you are attracted by the high liquidity in secondary markets, dont lose your control, and keep note of every small tendency. Good research and its application will be needed if you want to avoid the hidden pitfalls of the penny stock market and try to make a profit.