One way to grow your wealth is to leverage stocks. These are securities that represent part ownership in companies and can be bought and sold over the counter (OTC) or through markets like the London Stock Exchange (LSE).
You can increase your worth using stocks by buying them to earn dividends, holding to sell later after the price goes up or day trading them.
Our focus on this article is a type of the third option known as penny stock day trading. It involves buying and selling low-value stocks within the day for profit. Take a look at penny stocks trading guide for more information on technical aspects that are involved.
What exactly are penny stocks?
The concept of penny stocks originated in the US after the Securities Exchange Act of 1934 was enacted. The law established the Security Exchange Commission (SEC), the regulatory body that oversees the stock market in the country.
Its UK equivalent is the Financial Conduct Authority (FCA).
Among the first regulations, the SEC issued was that only stocks that traded for more than $5 (about £3.86) per share could be listed on a national stock exchange.
That meant that stocks whose value was less than $5 per share could only be traded over the counter. Besides penny stocks, they’ve also been known as OTC stocks.
Over the years, brokers have created elaborate marketplaces for penny stocks such as OTC Bulletin Board and OTC Link. It is also important to point out there are now many exchanges around the world, including in the UK, that list stocks valued under $5 per share.
Meanwhile, just like in the US, there are many stocks in the UK whose value is very low but still offer an opportunity to a day stock trader. Also, even as a British citizen, you could trade American penny stocks through brokers that take onboard non-American citizens. And you can do this online, meaning right from your home.
But what are the advantages of trading penny stocks?
When new investors decide to try day trading, almost by default, they gravitate towards the higher valued stocks. Indeed, the reputation and visibility of the major brands and companies behind them offer some form of assurance and security.
On the other hand, the low-value stocks of little known startups seem too risky to try. However, many make millions of pounds annually trading them. It turns out the penny stock day trading has a few advantages as compared to exchange-listed high-value stocks.
For example, the penny stock market is full of information inefficiencies. What exactly does that mean?
It means that you can easily find information leaks that allow you to act before the market reacts in a particular way. It is a lot easier to be proactive in the penny stock market.
For example, a penny stock company might file a notice of merger with a market regulator and then take a few hours or even days to announce it to the public.
Given that most market regulators today publish filings and notices on their official websites, a keen trader can know in advance that a stock price is about to go up or down. Based on this information, you can buy or sell a stock to make profits or avoid losses.
Another advantage of trading penny stocks is that they are highly volatile. That means their prices may move up and down many times throughout the day. In day trading price volatility is a good thing. It is an opportunity.
You also don’t need to have a huge account to start trading. That is because some of the penny stocks are literally selling for pennies. You can buy many shares from startups and also from many of them during the day using a modest account balance.
This, however, doesn’t mean you can’t make a lot of money trading them. Many have made a lot of money trading only this type of stocks.
Are there risks trading penny stocks?
Indeed, while penny stocks provide opportunities to make a lot of money, they are also highly risky. You could lose money just as it is the case trading any other type of asset.
The fact that little is often known about them, and indeed some can be very shady, the risk is even higher with penny stocks.
Also, because of their size, it is not uncommon for some people to promote them so that the price goes up for them to make a profit. This is known as pumping. It could be done by the company itself or independent traders who hold a significant amount of the stock and look to sell it at a higher price.
These are some of the reasons why you need to be very careful when you decide to trade penny stocks.
If you take the time to study it and develop a good strategy, trading penny stocks is another way to diversify your investment efforts.