Pros And Cons Of Trading Penny Stocks To Make Fast Money

Penny stocks are generally considered to be shares that are priced at less than one dollar. Stock market investors can find these traded sometimes on major exchanges like the NYSE and NASDAQ, but more often on secondary exchanges, often called pink sheets. Most major brokers enable traders to purchase low-priced stocks, but there may be restrictions.

I will use the term “traders” in this article, rather than “investors”. Penny stocks are high-risk. Stocks that are less than $1 generally have major problems associated with them, and rarely make good long-term investments. It is possible to make fast money by trading in cheap shares, but a buy and hold strategy often backfires on traders when dealing with these companies.

Positives of Buying Penny Stock for Quick Profits

Penny stocks are low-priced, and traders can purchase large blocks of shares for small outlays of cash. If a stock is priced at 50 cents, a trader can buy 1,000 shares for only $500, limiting how much they can lose.

Because the stocks are low-priced, they are often not followed by major investors such as pension funds, and mutual funds may be prohibited from investing in stocks with a price of less than $5.

A small amount of positive news may greatly impact the price of the stock. It is not rare for a stock to go from 50 cents to $1 and back again in a day or a week. It is important to be among the first to spot a move in a cheap stock to avoid becoming a bagholder, or someone who continues to hold on to a stock long after the fast money has sold it and moved on.

Occasionally, stocks priced in pennies recover. Sirius XM stock declined in price to nearly 10 cents but recovered to one dollar a year later. A cheap investment in this stock would have returned a ten-fold increase, known as a ten-bagger.

Cheap Stocks Can Go Bankrupt

Stocks generally have good reasons for having a price less than a dollar. Most likely, the underlying company situation is dire. In order to reach this price point, the value of the company must have declined, because companies do not come public at this price. Enough shareholders have sold in order to drive the price down to this level.

The biggest danger is that the company will go out of business, that is, declare bankruptcy, or go BK. Once this happens, all value of the shares is wiped out and the stock ceases trading.

Because the stock is not followed by analysts, and there is little trading volume, the price may not change for many days or weeks, and the trader’s funds become what is known as dead money, unable to be invested in other stocks. Margin is not allowed on low-priced stocks.

Brokerages do not allow short positions for retail investors, so traders cannot bet that the price will continue to decline. Some brokerages may restrict the number of shares that can be bought at one time, resulting in larger commissions to purchase a sizable position.

Big Profits or Big Losses on Penny Stocks?

If you are in a position to speculate on the stock market and have the patience and ability to discover great investment ideas, penny stocks can produce big benefits. For most investors trying to build a long-term portfolio, they are best avoided.

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