I talked about penny stocks a year or so ago, but it’s a subject I still get emails about every week, all asking basically the same thing: “Do you trade penny stocks, and if not, why not?”
The answer is unequivocally no! I don’t trade penny stocks, and I don’t recommend trading them either.
Why not? Well as I’m sure you’ve figured out by now, I like to try and make my life easy and stress-free. So when it comes to trading, I look for stocks with large range and good momentum, because they are easier to trade profitably. Penny stocks have neither range nor momentum. So they’re hard to trade. But don’t just take my word for it, let’s look at a quick example which will illustrate the point.
Here’s a chart for RIMM (yes, it’s an old chart, this is a redux post!) It’s a simple line chart to make the illustration clear:
At the time of this chart, RIMM is what I would call a regularly priced stock. Look at the range the price moves in between 9:00 and 11:00 – it goes all the way from $53.80 to $55.50, which is a $1.70 move. If you could take a trade that caught even just a small part of this move, you’d be in for a decent chunk of profit.
If you were trading a thousand shares (easy to do on margin) and you took just 25 cents out of this $1.70 move, you would make $250 profit. 25 cents is around 15% of the move. So as you can see, regular stocks give the opportunity to make good profits even if you miss 85% of the action!
Now let’s compare that regular priced stock with a penny stock. Here’s a chart for ACAD, the same day as the RIMM chart:
The price is around a dollar, which to me qualifies it as a penny stock. In the same time period as RIMM above (9:00 to 11:00), the price moved just 6 cents. Even if we waited until midday, the maximum range was only 10 cents.
Clearly, to make any money trading this stock, you’d have to catch all of the move. Catching a whole move from start to finish is hard! Catching 15% of a move is easy.
15% of the move on RIMM was worth four times as much as 100% of the move on ACAD. I don’t know about you, but I don’t really want to work six times harder to make four times less money.
Now at this point you might be thinking okay, why not just trade penny stocks with bigger size, to make up for the lack of range? To answer that question, we need to add volume to the charts we just looked at. Here’s RIMM again:?
The volume bars are 5 minute intervals, so in our 9:00 to 11:00 range, the volume of stock traded was around 100 – 200 thousand shares every five minutes. Now here’s ACAD with volume:
The volume was under 20 thousand shares traded every five minutes, and most of the time, well under. So you simply can’t trade huge size with penny stocks, because most of the tine there’s nobody to take the other side of your trade.
To recap then: I like to make my life easy. Catching a small part of a large move is easy, and also very profitable. Catching a large part of a small move is difficult, and much less profitable. That’s why I don’t trade penny stocks.