Penny stocks are a security issued by a small company that trades less than $5 per share. These are stocks that are generally quoted over-the-counter. Penny stocks are highly speculative, and the chances of losing your whole investment are quite great. So, who trades penny stocks?
Many of those who become successful in the frenetic world of trading are also those who carve out a certain niche in a certain sector or asset. Penny stocks are among these niches, even if the number of traders trading these stocks is very small.
For experienced penny stocks traders, the limited liquidity, wide bid-ask spreads, price manipulations, and the extreme volatility are not so surprising. They are usually day traders and swing traders and they usually take both long and short positions.
Speculation can be considered the life of the penny stock market. However, before a great volume of selling can take place, there has to be a huge volume of buying to happen to inflate the penny stock’s price.
A huge slice of this buying force comes from the long-term speculators that are familiar with the game and have profited from good penny stock trades in the past. These traders continue to speculate with the hopes of repeating previous successful trades.
A market maker is a broker-dealer that facilitates trading in a specific security by displaying bid and ask quotations for a certain number of shares.
Because market makers try to generate liquidity, they essentially become important contributors to the penny stock market’s trading volume. After receiving the buy order from the trader, the market maker may either sell shares from its inventory or buy them from the market for onward sale.
On the flipside, for a sell order, the market maker may either absorb the shares into its inventory or immediately throw them into the market.
Even the most experienced, conventional traders will sometimes fall for the supposedly hot tip on a penny stock with hopes of making a quick buck.
The hot tip may sometimes come from a friend or someone familiar who professes to be on the inside tracks with the penny stock’s promoters.
These investors may play with penny stocks once or twice but after sustaining some losses, they’re probably going calling it a day and stick to trading with blue chips and senior securities.
Wiser traders know that there are more money to be made by short selling penny stocks than by buying and holding them.
On the flipside, these traders may lack the capital required to endure the occasional short squeeze. They also have to depend on networking and leveraging their experience and market intelligence to determine suitable short targets whose shares will probably decline from the current levels.
Even though many financial institutions are prohibited from trading penny stocks, loosely regulated hedge funds are not required to follow such restrictions. Meanwhile, most hedge funds won’t trade penny stocks with long positions. They usually prefer short selling penny stocks that appear to have peaked after being heavily promoted.
Even though they typically trade for literally merely pennies, it can be dangerous to go short on them because of the possibility of short squeezes.