Now that we have some sort of an idea about what a penny stock is, I think it is time to figure out what a bad penny stock looks like.
Again, in many people’s minds, penny stocks have been viewed as the “Wild West” of the stock market, primarily due to the many stories of fraud and manipulation that have often plagued the arena of small-cap stocks. While there is little doubt that unscrupulous activities often take place in the penny stock markets, this doesn’t mean that the entire sector should be ignored altogether. There are indeed thousands of viable opportunities available to the astute investor; as an example, stocks such as True Religion Apparel and Pier 1 Imports have each traded below $1 before, but now both stocks trade at multiples of that price level, producing astounding quadruple-digit returns.
The problem is not so much that good penny stocks are hard to find as it is that the worst penny stocks are hard to avoid. To the untrained eye, it may be hard to tell the difference between the two. So what makes the worst penny stocks? There are several tell-tale signs that will give you the signal to pass on the trade and hold on to your hard-earned money.
One of these signs deals with the volume of shares traded on the stock. For the uninitiated, volume is simply a measurement of how many shares have changed hands in a given trading day. If you notice that a penny stock has very low daily trading volume (including intermittent days where there is no trading volume whatsoever), that is a dead giveaway that the stock is an illiquid stock. This means that it will be difficult to enter or exit the stock at a favorable price. Illiquid stocks are notorious for what is known as “slippage”, which is basically a scenario where you attempt to enter or exit a stock at a certain price, but you end up getting your order filled at a completely different (and unfavorable) price. In other words, if you ask to buy at $0.25, you may get filled at $0.31. This produces significant losses on a per-share basis, and it will make it more difficult for you to produce a profit. It is highly recommended that you stay away from low-volume penny stocks.
Another sign of a bad penny stock is an overly-hyped stock that has experienced a sudden, dramatic spike in price. If you can look at the price chart of the stock and see where the price has increased rapidly over the course of a few days, don’t bet on the price continuing in that direction much longer. This is usually a sign of a classic stock market scam known as the “pump-and-dump”. This means that the stock is being heavily touted by certain promoters or insiders in order to “pump up” the stock’s price, only for the purpose of selling out (i.e., “dumping”) the stock once the general public begins to come on board. Avoid the “pump-and-dump” at all costs.
Lastly, the final sign of a bad penny stock is any company that is in trouble with regulatory authorities such as the Securities and Exchange Commission, or whatever particular exchange the company trades on (i.e., NASDAQ, NYSE, etc.). This can be indicated by the presence of additional letters in the stock’s ticker symbol. For example, if the ticker symbol of XYZ Corporation’s stock is XYZ, you may see an additional letter at the end such as “E”, which indicates that the company is delinquent in its filings with the SEC, or if you see a “Q” at the end, it means that the company is in the process of bankruptcy. Avoid any penny stock that carries these extra letters in its ticker symbol!
These tips will help you to avoid the land mines of penny stock trading, and will hopefully assist you in putting your best foot forward when it comes to identifying viable penny stocks. Although risk cannot ever be fully avoided, by using these tips, you will be in a better position to make solid trading decisions, and you will be able to better recognize the worst penny stocks when you see them.