Day trading penny stocks can be pretty risky. It holds the same risk as any form of day trading, but penny stocks have the additional traits of being thinly traded, extremely volatile, and easily manipulated. Sometimes this manipulation is easy to spot, and you can actually trade in the opposite direction of the manipulation (usually shorting an inflated price). Whether or not you know how to spot and manipulate the manipulators, day trading penny stocks is a little different from trading the big boys.
There are many ways to define a penny stock. Some people assume every stock under $5 is a penny stock, while officially a penny stock must be traded off the major exchanges, on the Pink Sheets and OTCBB. More accurately, a stock trading at less than $1 (literally trading for pennies), is another way people will define a penny stock. Some of these stocks even trade a minute fractions of a penny, which is where traders get themselves into trouble, but we’ll get back to that in a moment. The point here, is that there’s no specific qualification for a “penny stock.” Traders will collectively refer to stocks that hold any or all of the above qualifications as “penny stocks” and it is usually meant to be an insulting term – many popular sites and chat rooms won’t even allow the mention of such stocks.
The reason for this derogatory treatment of penny stocks is for the simple fact that they are quite easy to manipulate, especially if you get a big enough audience. When a stock’s market cap is incredibly low (think microcap or less than $300 million; often much less), even a single investor or trader can have quite an impact on the stock’s price. Big sites and popular chat rooms often have a large enough audience to have a few people bite on one fake tipster; the fake tipster buys the stock (this may take a week or more of accumulation, because the stocks are so thinly traded), then he tells everyone on the site, forum or chat room to buy it too. “It’s going to run” he’ll say, and if he can get enough people to buy it, it becomes a sell fulfilling prophecy. When the stock makes some solid gains, the tipster sells his stock for a big profit, and the people who bought into the “run” are left holding the bag as the price sinks down to where it should be. Since everyone wants to sell at this point, there’s no one there to take the “buy” side of the trade, and those who didn’t get out early are completely screwed. You could get stuck in a losing position indefinitely. This is called the “pump and dump” and it’s been around as long as the stock market. It’s a fraudulent activity that the SEC will hammer you for, which is why reputable websites, chat rooms and forums squelch penny stock talk; they don’t want to get caught up in the SECs wrath. It also distracts from the discussion of “real” stocks and other tradable securities.
However, there is a smarter way to day trade penny stocks. This involves monitoring penny stocks for unusual activity. This unusual activity can include press releases, newsletter mentions, and unusual volume and price movement, waiting for the “pump” to start to peter out, and then short the stock right back where it came from. The great thing about this type of trade is that you’re selling at the top when people still might be trying to buy into the run; this means your orders are probably going to be filled. Same goes for the ride down; there will be a lot of people looking to get out of that stock, and you’ll be able to play the “buy” side role. Again, there will be no shortage of sellers for you to buy from. The biggest problem you’re going to run into with this type of trading is finding a broker that has a large book of shortable stocks. Many times you’ll find it difficult to find penny stocks that you’re broker is able to let you short, but if you’re patient, this can be a pretty decent way to make a buck or two.
I’ve never watched the DVD’s, but I believe this is the basic foundation the method of penny stock day trading used by Timothy Sykes from Profit.ly. Penny stocks aren’t discussed a whole lot on this blog here, but Profit.ly is a great place to learn about them. Their newsletters cover them quite well. Sykes is quite profitable and successful in the realm of day trading penny stocks, and he loves to teach, so you can be sure you’re getting a high quality education in day trading penny stocks over a Profit.ly.