Nov 16, 2011

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How Penny Stocks Work

How Penny Stocks Work: Explanation

how penny stocks workMost people who find penny stocks lucrative tend to wonder how penny stocks work.  The reason why this is a common question could be because they are not traded by big stock exchanges like NYSE, NASDAQ and AMEX. Essentially, penny stocks are comparatively cheap stocks that are normally traded at small volumes. The prices could in the range of $1 to $2. In fact, there are others that go for less than a dollar, hence the name.

How Penny Stocks Work:  Major Traders

One of the most fundamental issues regarding how penny stocks work revolves around who trades them. Normally, it is only pink sheets and over the counter stocks that trade these types of stocks. The reason for this is that their prices and traded volumes are generally low. In fact, stocks with low volumes and prices but are still trading in the major stock exchanges can also be referred to as penny stocks. Generally, in the quest to explain how penny stocks work, many experts will tell you that they are either traded by firms that are almost going bankrupt or small and new market entrants. The reason why the stock prices for the new entrants are low is that they are yet to penetrate the market.

How Penny Stocks Work: Differences with Regular Stocks

Basically, if you are conversant with the regular stocks, you will not have a problem understanding how penny stocks work, since they work more or less in the same manner. This means that the investor buys them for speculative purposes. He or she buys them hoping that their value will appreciate in future and he or she will sell them for a profit. The great thing about penny stocks over the regular stocks is the fact that they carry a higher return potential and lower risk. For example, if the stock for a certain company is trading at $100, it can only appreciate by a few points. On the other hand, the percentage of change for penny stocks is much higher. In fact, the lower the stock’s price, the higher the risk and returns as well. For instance, if a penny stock goes for 20 cents, an increase of 2 pennies in the value is equal to a 10 per cent appreciation. Conversely, if the price goes down, the decline is also huge.

Another prominent concern among potential investors relates to volatility. If you are serious about investing in penny stocks, you need to prepare yourself to deal with the risks associated with investing in penny stocks. Considering that they are traded on lower volumes, speculators can manipulate the market, which can push the prices up. What speculators do is inject a lot of money in a particular stock, and this will cause the prices to rise. When the other investors realize that the prices are going up, they will also invest in them, which push the prices even further. At that point, the speculators cash out their investments and the penny stocks go back to their regular price. This simply means that investors lose, while speculators gain. That is how penny stocks work.

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