Penny stocks get a bad reputation in the stock market, rightfully so, but that doesn't necessarily make them bad to trade. Most people actually start of trading penny stocks as opposed to what are known as "blue chip stocks." Like anything else, there are pros and cons to each. I wanted to share this post to talk about some of the misconceptions of penny stocks, and explain why I personally focus on them with my own day trading.
First, what even is a penny stock? No... penny stocks are not just stocks worth a single penny and no they're not just stocks worth less than $1.00. By definition, any stock priced below $5.00 per share is considered a penny stock.
Penny stocks are priced low for a reason. They're usually the stock of a lesser-know company with not-so-reliable reputation to their shareholders. That's why they have such a bad reputation in general, and is why a lot of people think trading penny stocks is pure gambling. At the end of the day, penny stocks offer day traders a lot more than most blue chip stocks offer.
A blue chip stock is the stock of a huge company with a great reputation. These are stocks like Apple ($AAPL), Amazon ($AMZN), Google ($GOOG), Facebook ($FB), etc... basically "household name" companies. Although these seem like the better investment options, they're not necessarily going to be the better option for an average trader.
Penny Stock Pros:
Higher Volatility: Penny stocks generally have much higher volatility than blue chip stocks, making them more high risk, high reward. A certain amount of volatility is needed for day trading! Without it there is not enough price movement to be able to get in and out of positions within the day like day traders do. The high volatility in the penny stock market is the reason traders are able to make 10%, 20%, even 50% or more in a single day... a very rare occurrence in the blue chip market.
Less Money Needed: With penny stocks you may be able to buy 1,000s of shares at a time with a small account when you'd only be able to buy a few shares of a blue chip stock. With that being said, penny stocks are usually looked at as the much better option for new traders with limited capital to start trading. In fact, that why most new traders do end up starting with penny stocks, which leads me to the third "pro."
Less "Competition": Your competition in the stock market is every single other buyer and seller. Everyone is competing against each other to get the best prices and to buy low and sell high for a profit. When one person loses money, another gains! So... would you rather be competing against multi-billion dollar funds and investment firms in the blue chip market, or a herd on new traders with little-to-no experience in the penny stock market? Now that's not to say there aren't still investment firms and algorithmic trading taking place in the penny stock market, but it is less common than it is in the blue chip market.
Penny Stock Cons:
Higher Volatility: A double-edged sword. As I already mentioned above, the higher volatility of the penny stock market can definitely be a big benefit, but if you're not careful it can also cause larger losses than you would experience with less volatility. This is why risk management and proper position sizing is crucial, especially when trading stocks with high volatility.
Less Volume: This is one of the concerns that most traders bring up when they talk about why they don't trade penny stocks. In my opinion, this doesn't make much sense as a "con" just for penny stocks, because there are plenty blue chip stocks with low liquidity and volume as well. As day traders, we have to adapt to the market on a daily basis. This means finding the stocks making larger-than-average moves with high relative volume and, usually, news or a press release to go along. Volume is only an issue with day trading penny stocks if you're choosing the wrong penny stocks to day trade.
Low-Quality Companies: Again, penny stocks are priced low for a reason. If they were multi-billion dollar companies with years of growing profitability, their stock price would reflect that. It's important to trade the stock, don't fall in love with it! You don't want to invest in a penny stock long-term, because the odds of you picking the next Amazon of Apple are slim to none. Instead, take advantage of the increase volatility brought by the penny stock market for day trading and look to the more reliable blue chip market for your swing trades longer-term investments.
As you can see, there are definitely some pros and cons to consider before diving into the penny stock market to start day trading. If you have the discipline to manage risk properly then they can be a great option to grow a small trading account in a short period of time. Otherwise, you may want to take things a bit more slowly by focussing your trading on less volatile, more stable blue chip stocks.
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