Penny stocks, which are
also referred to as micro-cap stocks, are defined by a
number of factors, which include their price, as well as
their market capitalization. Most investors will seek a
stock that is undervalued and inexpensive relative to its
price earnings potential, and micro-cap stocks have many
such stocks with prices that are under a dollar.
Additionally, these up and coming companies typically have
market capitalizations of less than 50 million dollars.
This wonderful area of the equity market can provide
investors the opportunity to achieve returns on their
capital of 200% or 300% within a very short time frame,
with risks that are commensurate with the returns.
Therefore, an investor needs to understand how to trade
these gems when the opportunity arises.
Micro-cap stocks are traded
on a number of exchanges, which include the OTC-BB
(Over-the-Counter Bulletin Board), the NASDAQ, as well as
on Pink Sheets (.pk). The exchange traded micro-cap stocks
are companies that are regulated by the SEC (Securities
Exchange Commission) and are obligated to provide a
complete and comprehensive financial overview of the
company's performance to its shareholders in the form of
quarterly financial statements and an Annual Report that
conforms to SEC reporting guidelines.
Over-the-Counter stocks
include any regulated, publicly traded stock that does not
trade on a national exchange. The strict requirements
imposed on public companies are advantageous to most
investors. Instead of having to guess the condition of a
financial corporation, all the investor needs to do is look
up their latest financial statement (10Q). The difference
between the OTC-BB market and the national exchanges is
that OTC companies do not have the same listing standards,
such as minimum price for listings. To the diligent or well
informed stock trader, this opens up opportunities to
locate these undervalued companies. But there are pitfalls
and mine fields.
Pink sheet stocks are an
area of the equity markets where the companies that are
traded are unregulated and do not have to conform to the
same types of financial reporting as exchange traded or
OTC-BB equities. These companies do not have to file an
annual report or quarterly financial statements. For
numerous reasons, the companies in this area of the market
have decided that they would rather not report their
specific financial results to a regulated group, but that
does not mean an investor cannot find out how well these
companies are performing or what's in their pipeline. An
investor can call a company directly or subscribe to a
reputable penny stock research firm to find out the
financials of a pink sheet traded company.
All types of micro-cap
stocks are traded through market makers, who are
professional traders that make prices in which they will
purchase and sell a stock. Market makers exist in all size
stocks, but their importance is more prominent when the
volume of a stock is relatively low. The price at which a
market maker will purchase and sell a stock will be
different and this difference is called the bid (the price
where a market maker will by a stock) and the offer (the
price where a market maker will sell a stock)
spread. In many cases the spread between the bid
and offer will be tight, but there will also be many cases
where a bid/offer spread will be wide (large). For some
penny stocks, a bid offer could be 50% to 100% of the value
of the stock. For example, if a market maker quoted a stock
with a bid at 10 cents and an offer at 30 cents, the spread
of 20 cents is 66% of the price in which an investor could
purchase the stock. To eventually sell the stock, the bid
would have to move up 200% for the investor to break even.
This is a key pitfall for an investor to avoid when trading
penny stocks.
As indicated, one way
investors and day traders can assist themselves in the
process of learning how to trade penny stocks is to
research and become associated with a capable micro-cap
research firm. Not only will this type of company provide
an investor with robust companies that are interesting and
undervalued, but they will also steer investors away from
companies that have wide bid offer spreads. Research firms
can provide the financials of pink sheet and OTC-BB firms
which can be difficult to find, excellent analytical tools,
and provide a framework for the investment
process.
Generally, before making a
recommendation of a hot stock pick, they will have also dug
into the company's "back story", and will publish that news
to their subscribers, often on an exclusive basis. This
early access and heavy lifting associated with researching
of a micro-cap stock can take an enormous amount of time if
performed without the services of a diligent research firm
with top analysts crunching the data. In fact, the best
research firms will send reaal time email and SMS instant
messaging alerts that will notify their subscribers of
companies that are fundamentally or technically undervalued
which have reached very attractive entry points. A
specialist firm will also refer a reputable broker that can
execute trades for you in a fair and efficient
manner.
Penny stocks can provide
investors with unlimited returns and numerous challenges,
but the process can be extremely rewarding if due diligence
in the process is performed properly.
