Reader Questions Answered

Penny Stock Research

The other day Tim Sykes answered a question he says he often gets: Why Is There So Little Useful Research Available On Penny Stocks? In typical vitriolic Tim fashion, he spews out a few of his views on the subject. Most of them I don’t really think get to the main point. [By the way, the penny stock category isn’t really just about a price below $1. It generally encompasses stocks with low market capitalizations and prices below about $10.]

Research comes about because of demand. There isn’t much demand for it in the penny stock arena.

You see, most institutional level market participants (mutual funds, hedge funds) don’t play in the pool of low priced stocks. The pool is generally too shallow. They cannot trade in sufficiently large size to make it worth their while. The market caps of the stocks in question are too little and there’s insufficient liquidity to allow these big players to move in and out of positions efficiently. Institutions are by far the largest consumers of research.

Also consider that low priced stocks often aren’t marginable. Brokerages look at them as being too risky to allow traders to trade them on margin. That thins the herd of potential big-time players down a little further. More research demand out the window.

Even for individual traders there’s a limit to how far one can go with penny stocks. As Tim knows from experience, penny stock trading isn’t scalable. That means you cannot continue trading larger and larger positions as your portfolio grows. There just isn’t enough market cap. Again, that’s one more reason interest in penny stocks is lighter than in other areas of the market.

Lastly, volatility scares people. Penny stocks are more volatile in general terms than higher priced, higher market cap ones. Some strategies can actually use this to their benefit, but a lot of traders just don’t have the stomach for it. That’s a bunch more demand for research gone.

Penny stock research demand may be small because there is less money at play in that area, but that doesn’t mean there aren’t opportunities.

I am definitely not going to say anything bad about penny stock trading. The guy I consider my markets mentor in many ways loves trading the small names because they can offer such great upside – and he often trades 6-figure positions. I’m also involved in some research on a trading system which focuses on low priced stocks to take advantage of the higher volatility. It’s just not the most popular sector, and as Tim likes to point out, it can be subject to manipulation.

By John

Author of The Essentials of Trading