Any stocks that have very low market capitalization and the trading starts below $5 are considered Penny stocks. These stocks are said to have a Nano cap i.e. having a market capitalization below 50 million dollars. These types of stocks generally do not trade in big stock exchanges like NYSE or NASDAQ and are traded via OTC (Over the Counter) platforms. These platforms are now online and anyone can invest in penny stocks with ease.
Understanding Penny Stocks
The Securities and Exchange Commission (SEC) has defined penny stocks as “any stocks trading below $5 for each share are termed as penny stocks”. These stocks are of small companies that have very few investors as they are not sure if they should invest in such companies. These are new growing companies that do not have huge market value and have limited resources. Due to this reason, they have very low liquidity as a result investors have a very hard time selling their shares.
As the risk of investing in penny stocks is very high, there might be more sellers than buyers of the stocks. Almost all of the investors investing in penny stocks are retail investors. Institutional investors do not have any interest in such stocks as they are very unstable. The word unstable is in the sense that the price of these penny stocks is totally dependent on the rumors which lead to a very fast increase or decrease in these stocks.
Most veteran investors believe that these stocks are very risky to invest in and would prefer to invest in companies having a small cap or micro cap rather than penny stocks. Only those who are full-time retail investors and know what they are doing with their money should invest in penny stocks as they might be huge if you invest the right way.
How does the price fluctuate in Penny Stocks?
The general factors that cause the fluctuations of any stock are the acquisitions of private companies, new customers, contract/bid wins, new business veterans joining the company, etc. While these are common for both types of stocks having mega-cap or nano-cap. Along with that, there are other factors that affect the price of penny stocks. As penny stocks are more volatile companies, any investors investing in penny stocks should do intense research before considering investing in these stocks. Here are other factors that drive price fluctuation in penny stocks.
- Trading Imbalance:
In the case of penny stocks, this term is always repeated by many big investors. Trading imbalance is the scenario in which the number of buyers and sellers on a given day are very far apart. Suppose that there is a penny stock with a buying side of $5000 and in the next minute a huge amount of stocks are being sold, let’s say $45000. In this scenario, the amount between buying and selling has a large gap causing the stock price to drop in a continuous fashion until these stocks are sold out. This might take weeks to sell out and stabilize the stock.
- Hype from Media:
Media plays a huge role in the price fluctuations for not only penny stocks but also other kinds of stocks. Due to media coverage, the investors are pulled to these stocks either to buy the stock or to sell the stocks causing the huge price fluctuation in the stocks. Stocks having large caps have also become the victim of media-driven hype, one of which is a SPAC called Digital World Acquisition Corporation (DWAC). It was trading at $10 and due to the involvement of Donald Trump and media hype, the price went up by 400%.
- Company’s Growth:
At the start of penny stocks, they are very small companies or startup companies that are looking for more capital to expand their market. Companies will utilize the capital they have generated from the IPO to make more quality products or market their existing product. In both scenarios, if the company succeeded then its revenue will be increased and the Net Asset Value (NAV) per stock will increase. This in turn increases the stock price which will attract other retail investors to invest in these stocks. As a result, the demand will increase and so does the stock price.
Penny Stock Investment Guide
As there are multiple factors that cause price fluctuations in penny stocks, this increases the risk of investing in such stocks. Although the investment in these stocks is risky if you do it the correct way you might get a profit. Here are some of the strategies that you can use so that you won’t lose what you have invested.
- Always research
Before you invest in any penny stocks, you should do a good amount of research about that company. Generally, brokers will send you messages to invest in these stocks saying that you will get a huge profit. Don’t listen to the messages, get proper research. Try to read their monthly filings, find out what the total asset company has and what is the amount of liability. Once you have understood all these, you can generalize if it is good to invest in the stock or not.
- Do not hold:
Investors who generally invest in companies having mega-cap or large-cap always try to hold their stocks for the future. Large-cap companies do not fall apart in a matter of a day but these stocks do. Always think of getting a handful of revenue from what you have invested in penny stocks. Maybe 20% to 30% is enough. If you are thinking that you will be getting a 1000% return by holding for months then you might lose what you have invested.
- Penny stocks with high trading volume:
The main problem with penny stocks is that most of them are silent and do not trade that much. If you invest in penny stocks that have very low trading volume per day then it might be difficult to get out of it. So always try to invest in penny stocks having large trading volumes. Generally, trading of 100000 shares per day is considered a high volume.
- Always read news about the stock:
This is considered a very good habit for every investor. Not only for penny stocks but also for any kind of stock, reading about new changes in the company is always helpful. Always follow up with what people think of those stocks, and what the future trends will be. Any new changes in the company, if it is negative be ready to sell the stocks, and if it is positive just hold your positions.
- Do not purchase a lot:
Purchasing the penny stock is easy but selling is difficult. You always need to keep this in mind before purchasing its stocks. Also, if you already have a lot of stocks, what you can do is try to trade them in fractions. i.e. do trading around 10% of your purchased volume every day so that you can be in a safe zone along with a good amount of revenue.
Penny stocks are very volatile to the rumors which cause the price fluctuation. If you are thinking of investing in Penny stocks, always do enough research before you start trading. Yes, these stocks are risky but also provide huge revenue if you know what you are doing with your money.
Meanwhile, you can also invest in SPAC stocks. SPACs are less risky and have respect among investors. SPAC analytics tools like SPACrun can help you analyze the market. SPACrun provides real-time alerts whenever there is any SPAC stock news, merger news, de-spac news, and more. Signup to SPACrun to get a free trial.