Penny stocks are high-risk investments known for their wild price changes. But why do penny stocks fluctuate? Follow along for a full breakdown of penny stock price fluctuations and more.
About Penny Stocks?
A penny stock is a stock that trades at a share price of less than $5. It is usually a small company’s stock that is infrequently traded and has few buyers.
Most penny stocks trade on the over-the-counter market (OTC) through a broker dealer network.
They don’t trade on a centralized stock market, like the New York Stock Exchange. This is because these stocks do not meet the criteria to be listed on major exchanges.
However, not all OTC stocks are penny stocks. Many foreign stocks are also listed on OTC exchanges (e.g., Nintendo).
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Why Do Penny Stocks Fluctuate?
Penny stocks fluctuate because of their inherent volatility.
Volatility is the standard deviation of the returns from a stock over a given time period (for example, over a day or a month). The higher the volatility a stock has, the more its price will fluctuate.
But what drives this volatility?
There are two main factors: speculation and low float.
These driving forces make penny stocks exceptionally vulnerable to outside pressures that cause stock prices to fluctuate.
A penny stock often represents shares of a company that is unproven or doesn’t have strict corporate governance norms.
For example, many penny stocks are tech and biotech startups trying to raise money to fund their plans by trading shares in their business on these OTC markets.
Information about the actual company is very limited due to a lack of corporate governance and reporting.
Some of these penny stock companies may not even have to file their financials with the U.S. Securities and Exchange Commission.
In such cases, there is no way to determine the actual financial health of their business.
Traders speculate on stock prices based on media reports or other unverifiable sources. While this is partially true for mid-caps as well, it is much more pronounced in penny stocks.
Any negative news can send the stock price tumbling, while positive news can send the stock price soaring.
This is why penny stock trading ends up being a risky investment. Those trading penny stocks don’t have much “real” information to go on.
The “Float” of a stock is the number of shares freely available to trade (which excludes those owned by company insiders and execs). Penny stocks often have a low float.
This means a single person or a group of people who own a large chunk of the stock can easily influence its traded price.
For large blue-chip companies, there could be millions of trades occurring every second. So it’s almost impossible for a few large trades to move the needle on the stock price.
But if a stock is thinly traded and the volume of trades is low, the price can vary greatly with even a few trades.
How High Can Penny Stocks Go?
There is never any limit on how high a stock can climb, and the same is true for penny stocks.
We mentioned that tech stocks often start out trading at below $5 prices in their early days, technically making them penny stocks.
Well, some of those low-priced stocks went on to become Apple, General Motors, Ford, and AMD!
Once a penny stock consistently rises above the $5 mark, it is no longer a penny stock.
How Do You Know if a Penny Stock Will Spike?
It is very difficult to predict spikes in volatile penny stocks, but with strong fundamental and technical analysis, you might be able to see the signs.
Start with fundamental analysis to identify penny stocks that might spike.
Understand the industry, go through the company’s financials, check their profit margins, and compare how competitors are doing in the same space.
Look at their sales pipeline and any large contracts they already have in place. Also, study feedback from customers on a company’s quality of products.
In the case of startups, evaluate the management as well. Check their past performance in similar startup roles.
Technical analysis traces stock performance on a trading chart. Technical analysis tools can help you look for consistent gains and any spikes due to stock promotions.
Smart investors will try to build positions by buying up rising penny stocks, which will increase trading volume. So look for consistent growth in volume as well.
Volume and price increases are key indicators: but these do not guarantee that a penny stock will break through.
Some companies employ a pump-and-dump approach to bolster stock price and then quit when the price is high.
To avoid such a scenario, check on websites that list such possible pump and dump stocks. Forums are a great place to investigate a stock.
How Low Can a Penny Stock Go?
Technically, a penny stock can go down to zero! This can happen if the company files for bankruptcy. This will wipe out the investors’ investment.
For shares that are traded on major market exchanges, there are thresholds set up that delist a stock when it falls below a certain level.
Is It Worth Investing in Penny Stocks?
Penny stock investing is risky. Spotting the right penny stocks requires a lot of fundamental and technical analysis, and even then, it is hard to make money trading stocks like these.
Some people think that because these stocks are cheap, penny stock trading is a wise place for first-time investors to start trading. This is far from the case.
A person who does not know how to do the rigorous analysis needed for volatile stocks can lose a lot of money.
Even small absolute movements in penny stocks are big in percentage terms, so if you put a lot of money on them, you may lose your entire investment.
On the other hand, with a deep understanding of penny stock trading, it is possible to make a hefty profit.
Final Thoughts: Why Do Penny Stocks Fluctuate?
Penny stocks fluctuate due to because of their low float and a lack of publicly available information.
Buying a volatile stock and making a profit off it requires rigorous fundamental and technical analysis, especially a penny stock.
You can lose all of your money if you don’t do your due diligence.
If you are a beginner investor, investing in penny stocks may not be a sound idea. They are not undervalued stocks; they are just low-priced stocks.
Moreover, they are volatile, and it is difficult to find penny stocks that are consistently spiking in value.