Table of contents:
- 1 What Are Penny stocks?
- 1.1 Trading With Penny Stocks
- 1.2 Who Can Trade Pennystocks?
- 1.3 Where Can I Trade Penny Stocks?
- 1.4 How Can Penny Stocks Be Traded?
- 1.5 Potential Of Penny Stocks
- 1.6 Differences Between Penny Stocks
- 1.7 Pennystocks In The USA
- 1.8 Pink Sheets
- 1.9 Price And Share Volume
- 1.10 Chance Or Risk Of Bankruptcy?
- 1.11 Dead Cat Bounce
- 1.12 How Good Are Pennystock Recommendations?
- 1.13 Mantle Speculation
- 1.14 When The Penny Stock Bubble Bursts
- 1.15 Fraud With Penny Stocks
- 1.16 Alternatives To Penny Stocks
- 1.17 Risks With Penny Stocks
- 1.18 Minimize Risks
- 1.19 Conclusion On Penny Stocks
Anyone who has seen the Wolf of Wallstreet and Leonardo DiCaprio or knows the odd blockbuster on the stock market has already heard the term penny stocks or pink sheets. But only a few people know what to do with them, because the terms cover a large mass. Depending on the definition, there can also be differences, as a penny stick in Germany is not necessarily the same as a penny stick from the USA. Therefore we want to approach the world and the knowledge about penny stocks with this article
What Are Penny stocks?
The name Pennystocks is made up of the two words “penny” and “stock”, i.e. a small amount in the penny range and the word share. This makes it easy to explain what a penny stock is. Basically nothing else but a share, which can be traded for a few cents or pennies, depending on the trading place.
As a rule, these are companies that are about to go bankrupt or are already bankrupt. The shares of such a company are then no longer worth too much and are often a penny stock. Depending on the circumstances, this wave of bankruptcies may have been preceded by certain signals that have provided a good investment opportunity for short sellers.
In Germany, a penny stock is any share worth less than one euro. That is why they are rather poorly performing companies. Others may start out as penny stocks because of their volume and the foreign currency conditions. Like the notorious Nel Asa share in the recent past or Aston Martin. This was or is by definition a penny stock, at Nel Asa the recent upswing has led to significantly higher prices far from the 1 Euro mark, at Aston Martin one can still speak of a penny stock.
Trading With Penny Stocks
Pennystocks can be traded with most brokers such as Comdirect, OnVista, Flatex etc. There are no particular specifications, as it makes no difference to the broker whether it is an Amazon share at 2,500 euros per share or a penny stock at 0.50 euros per share. Therefore the order fees and all other fees are the same. Pennystocks are therefore not a separate asset class, but are defined purely by the enormously low value per share.
However, anyone who wants to trade with an already ailing company should know that this is a high-risk trading. Trading with penny stocks can lead to a total loss, as it is not uncommon for an already insolvent company to lose the last bit of money and either become delisted or reach a stock market value of EUR 0. One should always be aware of this.
Anyone interested in trading penny stocks should therefore only invest in a smaller financial framework. Some then consider this to be play money like in the casino. In other words, money that you can do without in an emergency. The smaller the amounts invested, the smaller the potential loss. However also the smaller the potential profit. One should also pay attention to the respective order fees of the broker. If you pay 10 euros per order, you cannot afford to invest only 300 euros, as the transaction costs are far too high. In this case, an inexpensive broker such as Trade Republic is recommended.
Finding the one penny stock that is best to leave the penny stock sector and make decent profits is a difficult undertaking. It may succeed, but the probability of long-term success is relatively low.
Who Can Trade Pennystocks?
There are no restrictions whatsoever on trading penny stocks. So if you own a securities account and have access to penny stocks through your broker, you can also trade in them. Special knowledge is not required here.
However, as with all trades – you should have a certain basic understanding of the stock market and its movements. Otherwise trading with penny stocks could quickly lead to losses.
Where Can I Trade Penny Stocks?
In order to be able to trade with penny stocks, there is no particular provider among brokers. This works with all common brokers. They only need to have the desired pennystocks in their offer. However, the brokers themselves sometimes differ greatly in their fee structures, which is why a broker with low fees is advantageous here. In addition to the already mentioned Trade Republic, one could consider the LYNX-Broker or Interactive Brokers if one wants to trade penny stocks from the USA. These are not tradable with most German brokers. LYNX, on the other hand, specialises in such US pennystocks and also offers reasonable order fees. Of course, other stocks are also tradable there, but the selection of penny stocks is probably the largest of all competitors.
Foreign shares and the German penny stocks are traded on the open market (the so-called Open Market Segment). This is where the shares that do not meet the admission requirements of the regulated market are placed. As a result, the shares in the Open Market Segment are subject to less rigid requirements such as the obligation to submit quarterly reports, balance sheets or publication obligations.
How Can Penny Stocks Be Traded?
When trading penny stocks, you do not have to proceed differently than with all other shares. You select the penny stock with potential, set a volume and enter the order into the order book with the broker. When this is executed, the shares are entered into the securities account in the desired quantity.
In order to find a penny stock with potential, one must naturally, as always, think about different scenarios and ask oneself how and whether the penny stock can move in the desired direction. To do this, one should look at company key figures and reports. Common stock screeners such as the Stock Finder or the AllShare Quality Score are less advisable here, as they do not usually illuminate penny stocks.
Potential Of Penny Stocks
Those who deal with penny stocks often overestimate the potential of a stock. Everyone is talking about Aston Martin at the moment and some see it as a suitable penny stock to earn good money in the long term. After all, most pennystocks, and thus Aston Martin as well, come from a much higher level and have not been in the pennystock segment for years. This attracts some people to the idea of fast money. However, one must also ask oneself why the shares have moved so far away from their all time high and whether they can ever return there.
Some investors therefore fall for the mathematical misconception that it must be much easier to double the share price if it is 10 cents per share. After all, the leap to 20 cents is so small and hardly far away. Other papers fluctuate around such amounts in seconds. But to make 10 cents double the price, a relative price increase of 100 percent is necessary. If a share is to climb from 50 euros to 100 euros, then for some this seems much more unrealistic. But the 100 percent price increase is necessary in both cases. This should not be forgotten.
Conversely, if a share has fallen deeply, this is no guarantee for faster price increases. Studies of various studies have even suggested that weak shares tend to underperform and are therefore not a good investment product.
The trading volume of a share is also decisive for the price trend. With a penny stock, this volume is very small and there is often a large difference between the bid price (Bid) and the ask price (Ask).
On the other hand, one should not forget that some pennystocks are actually often affected by extreme price fluctuations and that there is a lot of money to be made with clever trades.
Differences Between Penny Stocks
As shown above, the rule of thumb for determining a penny stick is quite simple. Every share that is endowed with less than one euro is a penny stock. However, this is not always reliable and a uniform penny stock definition will be difficult to formulate. After all, a penny stock often suggests a practically worthless company. Some countries, however, are proof that a penny stock does not necessarily have to be a penny stock.
Looking at the level of the Vodafone share, one could quickly get the impression of an approaching penny stock. At times, this share was very close to the magic one-euro limit. However, the company itself is solidly positioned and does not have one foot in the door of bankruptcy. However, the price is so low because there are a large number of Vodafone shares on the market. This makes the share price correspondingly smaller, but the company itself is still very valuable and far removed from the actual penny stock.
Also at the stock exchanges in Australia or Hong Kong, there are those companies that at first sight seem to be an approaching penny stock, but actually can hardly be called a penny stock with all its facets. The world’s leading producer of bauxite and aluminium from Australia, Alumina, is currently at pennystock level, but it is not yet possible to deduce any imbalance of the company in this case.
Pennystocks In The USA
The USA represents a completely different exceptional situation. Because there, penny stocks meet other requirements. Whereas in Germany the one-euro limit is higher, in the USA all shares with a market value of less than USD 5 are called penny stocks. This is not so much due to a magical or imaginary limit as to the fact that a minimum price of USD 5 per share is required for the US market. Otherwise the company cannot be listed on the major NYSE or Nasdaq stock exchanges.
For this reason, such companies with less than $5 per share can be found as so-called over-the-counter (OTC) trading – i.e. over the counter – similar to over-the-counter trading. These are then listed and tradable as so-called pink sheets.
These Pink Sheets (according to the meaning of the word, the necessary information about the shares and their transactions are printed on pink paper sheets, after which the name is derived) are an over-the-counter trading platform of the private bank Pink Sheets LLC and can only be found in the USA. To be traded on Pink Sheets, no more detailed requirements have to be met. As a result, they are not subject to any legal requirements, similar to the over-the-counter market, and registration with the US Securities and Exchange Commission (SEC) is also not required.
This poses a particular challenge for investors, as it is difficult to obtain reliable information because there are no disclosure requirements. Consequently, most of the information on the Pink Sheets is rather unchecked and should be treated with great caution. The price fixing of these Pink Sheets is also not subject to any real rule, which is why they are genuine gambling papers. These Pink Sheets have also often been the basis for fraud, which was filmed in the Wolf of Wall Street mentioned at the beginning of this article. The stockbroker Jordan Belfort, whose life and work on the stock exchange was portrayed in the film by Leonardo DiCaprio, was able to live in wealth for years with these fraudulent deals through penny stocks and pink sheets. But this fraud was punishable by law and so Belfort got the criminal receipt. Today he is therefore no longer on the stock exchange, but works as a motivation trainer.
The price of shares is often also determined by the volume of shares. In some of the countries already mentioned, such as England or Australia, this is related to a different equity culture and also a completely different stock exchange law than in Germany. Like Vodafone, the aforementioned Alumina has an immensely high volume of shares, which is the reason for the low share price.
This is because in these countries a capital increase can usually be carried out at prices of a few cents. This naturally leads to a certain distortion of the share capital. In Germany, for example, a minimum price of 1 euro would be required for such a transaction. For this reason, German pennystocks are really only shares which, without a consolidation of shares, the so-called reverse split, no longer have the possibility of refinancing through a capital increase. German pennystocks should therefore be treated with greater caution once again, as they are really real bankruptcy vultures. We should refrain from real German penny stocks because they are more like junk on the rummage table or the scrap yard. A real price recovery is rather impossible with these.
Chance Or Risk Of Bankruptcy?
In principle, penny stocks offer high opportunities for risk-averse investors. Anyone who lands a good trade here can indeed expect a profit of several hundred percent. If you look at Aston Martin once again, for example, a penny stock can increase in price by around 300 percent from its low point to its last high point. But to do this, you have to realize profits at some point. Because at the moment it is “only” 7o percent. Some people hope for earlier prices of 2 to 4 Euros for this particular share due to the Formula 1 entry, a new management, a new car etc. That would be very desirable, but is probably pure wishful thinking.
Aston Martin is here only a symbol for many other companies and hopes of the pennystocks. There is a chance, but you still have to analyze and select companies that not only have a desired potential.
The risk of bankruptcy, on the other hand, is much higher. If only because some penny stocks are pure shell companies, i.e. the listed remainder of insolvent companies. These companies never have the chance to experience a turnaround or distribute profits again. Especially in the over-the-counter market, stock exchange trading continues even years after an insolvency. There are no prospects of success here. The only advantage for the investors, one can realize losses in order to claim them for tax purposes. Advantage for the banks, they continue to earn by order fees through possible transactions. Other advantages can hardly be found.
Dead Cat Bounce
The so-called dead cat bounce is a metaphor that can be applied to some stock market developments. In the case of penny stocks, the macabre image of the dead cat is increasingly found. In the original English version, the phrase “Even a dead cat will bounce if it is dropped from high enough!” means that a cat that falls from very high will bounce and jump up again a little. This means that some penny stocks are showing strong price swings because traders are entering the stock en masse. In times of social media and social trading this has become even more pronounced. So the stock market influencers post their purchase and some of them follow suit. Even an increase in trading volume is enough to unleash a huge demand for what are actually dead stocks. However, this dead cat bounce is not characterized by sustainability. An experienced trader can certainly make money this way, but the inexperienced ones follow the short-term trend and tend to lose money.
How Good Are Pennystock Recommendations?
The stock market trades the future and is always a bit ahead of the real economy. So much for another stock market wisdom, which certainly has its justifications. However, experience also shows that the sooner the market presents itself in a massive upswing, the sooner the penny stock will also boom. Not because they are ahead of the economy and ahead of life, but because irrational actions tend to occur. Instead of buying healthy companies according to a sound company analysis, many invest in the latest trend. These are then found in enough internet forums and very often the very sectors in which one should definitely invest are already clearly overheated and at least a short-term bear market could be just around the corner.
We have been able to follow such stock hypes in marijuana stocks, for example. But if it turns out that there is little or no substance to be found in the emerging penny stock boom, they will fall as fast as they have risen. Whoever does not prove good timing here will not be able to succeed. This is why pennystock recommendations in stock exchange forums or Facebook groups are not a good and reliable source. One share may be there, but filtering it out of all the bad ones requires some skill.
As described above, some bankrupt companies are used as shell companies. In this way, other companies can go public without an IPO (Initial Public Offering). This saves time and money for the IPO. This process is also called Back Door Listing. However, to do this, one must own the majority of the existing shares in the insolvent company. Various measures then certainly lead to a resurrection of the stock corporation.
Such methods often develop into speculation. Investors therefore assume that the revival of the company will lead to rising share prices. Those who are prepared to take risks can trade with such a penny stock with good chances. However, the actual stock corporation is still worthless and therefore there can be a risk of losses. However, anyone who is good at such trades will not find a better profit opportunity in the penny stock segment.
When The Penny Stock Bubble Bursts
So you can see that the pennystocks are difficult to look at in a well-founded way, as some information is hard to get and other information has to be treated with caution. The trend or real booms often determine the price behaviour of a penny stock rather than serious analyses. That is why the inflation of such penny stock bubbles is not uncommon. As always, this bubble will burst at some point and anyone who has not already taken profits or limited losses may lose everything.
Fraud With Penny Stocks
The Wolf of Wall Street is a prominent example of penny stock fraud. The penny stock bubble can also burst due to illegal activities and can drag the normal private investor into the loss zone. For this reason, false information about individual companies is often deliberately disseminated in order to then earn a lot of profit with the price increases of the penny stocks. Entire networks then pursue the goal of triggering the next boom and convincing as many investors as possible of the chances of profit.
However, these scams run without substance and in the end only fill the account of the scammer network. Fake internet pages with professional articles and buying recommendations, news in all internet forums etc. are part of the strategy of the fraudsters. Thus, the less experienced traders are foisted with penny stocks that have no substance at all. Such a fraudulent network could be uncovered in the USA in 2013. Up to now, these traders had earned around 140 million US dollars with their methods. But the private investors lost a lot of money.
Alternatives To Penny Stocks
Penny stocks are high-risk investment opportunities that most investors would rather not consider or should not consider. The risk/reward ratio is sometimes far too high. Instead, there are alternatives to penny stocks that offer better opportunities.
Small Cap Stocks
One alternative is small cap stocks. Like penny stocks, these have a low market capitalisation and the total value of the shares is also rather low. However, unlike most penny stocks, small cap stocks still have an operating business. These are therefore not insolvent companies with no real business activity, but companies that are still functioning.
Those who enter the market at a low level can quickly expect large price gains. One example could be the story of Cancom. For many years, this cloud computing company was more of a penny stock than a serious stock. With the expansion of the cloud computing division and the great demand for this technology and service, Cancom’s share price has climbed from 0.62 Euros in 2008 to almost 50 Euros today. This is a success story that all investors would like to see.
Such small caps are particularly common in the IT and biotech sector. That’s why they are usually more useful than penny stocks. Likewise, small caps are not found in the open market but in the regulated stock market.
The second alternative is turnaround stocks. These are stocks where the positive expectations around the company are leading to a new impetus and a turnaround. For example, the share price could have fallen for a long time because the business figures were no longer convincing. If the first positive signs of improvement appear, this could be a good entry opportunity. There are plenty of prominent examples, including Apple and Puma.
Of course, one can also be wrong with turnaround stocks, but these are also companies that still have an operating business and offer prospects for improvement. This minimizes the risk of loss compared to penny stocks.
Risks With Penny Stocks
As we now see, the risks involved in trading penny stocks are relatively high. So you have to ask yourself how willing you are to take risks and whether investing in a penny stock is a good investment idea. If you are willing to take a risk, you can make a profit with penny stocks. However, the risk/reward ratio and the willingness to accept a total loss must be taken into account.
It is therefore advisable to invest in such penny stocks with play money rather than with the highest sums.
But you can also minimize the risks involved in trading with penny stocks. To do this, you should collect and evaluate as much information about the company as possible and carry out a sound analysis. Likewise, one should not chase every trend in a stock market forum or see a different boom every day. It is also advisable to take profits from time to time and not to let them run forever. On the downside, one should work with a stop loss to limit losses. However, pennystocks are subject to strong fluctuations, which is why you can quickly stop them up or down.
Conclusion On Penny Stocks
Pennystocks are certainly a way to trade interesting opportunities. However, this asset class is rather recommended for experienced traders and short sellers and not for private investors. The former are better able to react to the opportunities and risks with their experience, the latter should rather consider other investment possibilities. Small cap and turnaround stocks might be the better alternative.
However, if you have some play money left over and can live with a total loss, you can also simply invest in a promising penny stock and see what comes out of it. However, this is really only recommendable with play money in an amount that is bearable.
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