What Are Penny Stocks?

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Video Transcription:

Hello traders. Welcome to the stock trading course and the 8th module penny stock trading.

In this lesson, we are going to define what penny stocks are. And the reason we need to define what penny stocks are is because the actual definition and the actual criteria is very vague.

So a penny stock is a stock that trades at a relatively low price and market capitalization. They usually trade outside the major exchanges such as the NASDAQ and the New York Stock Exchange. These stocks are considered to be highly speculative and high-risk because of their lack of liquidity and small capitalization.

Penny stocks usually trade over the counter through the OTCBB and Pink Sheets. Now, the OTCBB stands for Over-The-Counter Bulletin Board and it’s a regulated electronic trading service offered by the National Association of Securities Dealers or NASD.

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Stocks that trade on the OTCBB don’t have listing requirements like on the NASDAQ and the New York Stock Exchange. But are required to file current financial statements with the SEC. Now, Pink Sheets are a daily publication compiled by the National Quotation Bureau with bid and ask prices of over-the-counter stocks.

Companies listed on Pink Sheets do not need to meet minimum requirements or file with the SEC. So as you can see, these companies are not only small, risky, and highly speculative, but they also are very hard to read because they don’t need to file anything with the SEC or the exchange to be able to get listed.

Some people think that penny stocks are old stocks that trade for pennies, but the reality is that penny stocks can trade for $5 a share for example. And as many stocks can trade for $5 a share, there are very, very large companies that also trade for $5 a share. So when we are talking about penny stocks, we are not going to be focusing on the price of the stock, but we are going to be focusing on the capitalization of the company. We are going to look for micro-cap companies, and we are going to look for highly illiquid shares.

If we find a company that’s trading for $5 but the market capitalization is below $100 million, and its shares don’t have more than 10,000 shares traded per day as volume, we know we are in front of a penny stock. Now, this doesn’t mean that we are going to be trading right away illiquid stocks from micro-cap companies. But we can ask ourselves, why do we want to trade penny stocks if they are so risky and speculative.

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Well, the reason is because they are highly speculative. And because they are highly speculative, they can generate returns ranging from 100% to 1,000% in a matter of hours or days. Because their price is so reduced, we can have large holdings with limited buying power. So this is great for small account holders looking to grow them.

Now, what strategies are we going to use? Because penny stocks trade very differently for normal shares, we can’t use the day trading techniques we learned in Module 4. Penny stock trading is completely different, and you won’t be trading the same stock on a daily basis.

What we are going to focus here is the news, the hype, and unusual volume on the stocks.

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