The Securities Exchange Commission defines penny stocks as stocks of small companies priced at or less than $5. These typically are young companies still at their initial growth stage. Investors seek out penny stocks to get in early on a new company. These companies often have the potential to grow into blue chip stocks that trade on the major trading exchanges. The trick for investors is to know how to look for such promising stocks, and to know when to add them to their portfolio.
Buying Penny Stocks
Penny stocks do not trade on the main exchanges such as the New York Stock Exchange or the Nasdaq. Instead, they trade over-the-counter on the OTC Bulletin Board. This is a quotation system in which market makers set the price of the shares they are selling. Investors who want to buy these penny stocks early usually do so through a broker dealer. The broker dealer will get a quote from the market maker over the phone, via email or through a proprietary trading system.
Finding the Right Stock
The prices of penny stocks are especially volatile. The price can shoot up in one minute and revert the next day. Traders looking to benefit from a rally in the stock can find it hard to predict; such rallies also tend to be short-lived. However, some investors use fundamental analysis to infer when a penny stock is going to experience a growth spurt. One example is looking at the general trends in the industry or sector in which the penny stock company is a part. A booming industry can have a strong pull on penny stocks, making them more attractive to investors.
Buy-out news or merger rumors can send the price of penny stock companies higher. This is good for investors who already have a share in the company. In order to take advantage of similar events, investors keep an eye on larger, established blue-chip firms that are looking to buy up a penny stock company at its initial stage. Similar companies in the same industry, or companies with complementary business objectives or products, eventually can decide to merge together.
Another technique used to evaluate penny stocks is the Leeds Analysis. Part of this analysis looks at the company’s marketing strategy. Examples are the company’s brand awareness, its positioning in the industry and how well it is differentiated from other products. Investors who are aware of the company can dedicate time to research and then buy the stock. The effect on the stock price is compounded as investors flock in droves to buy up the cheap, familiar stock.
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