Reader Questions Answered

Penny Stocks or Forex for the new trader

I had an email come in with a set of questions from one of my newsletter subscribers yesterday.

Two weeks ago yesterday, I began my venture into learning how to day trade. Expect to start in Penny Stocks &/or Forex. Here’s my Q’s…

1. Which one do you suggest I try first, Penny Stocks or Forex? Penny Stocks I’ve studied the most already.

2. How do I open a paper account, (to practice what I’ve been studying about Penny Stocks) the same Broker I plan to open my actual trading account with later, or somewhere else?

3. I like what I see at Peter Leeds web site… the list of Brokers he recommends, (as choices for opening our 1st trading account) and system he’s developed for picking stocks he recommends to those who subscribe to his newsletter. What do you think of his expertise?

Any suggestions for helping us get started, are greatly appreciated.

Let me start with the last question first. I don’t know Mr. Leeds, nor am I familiar with his website, system for picking stocks, or his newsletter. As a result, I cannot speak to his expertise or the value of what he does.

When I am confronted with questions like this my standard response is that you need to make sure whatever product or service you’re contemplating investing your money and/or time in is what you need right now to either further your trader development or to improve the efficiency and effectiveness of your work developing trade ideas and/or managing positions. Way too much money and effort are invested into things which don’t fulfill those criteria. This is largely because the person in question hasn’t taken the time to build up their foundational knowledge and worked through the process of understanding how they need to approach the markets and their own trading. Helping them do that is the major driving focus of what I am trying to do with this site and my various educational efforts.

Getting back to the other two questions…

Penny Stocks vs. Forex
I cannot tell you penny stocks or forex is better. Both have their strengths and weaknesses. A major factor in the decision, though, is time. You won’t be able to trade penny stocks outside exchange hours, so if that is something important then you’ll have to go with forex. On the flip side, there are only a limited number of really tradable currency pairs, so if working with a broad array of potential trading vehicles is important for your strategy, then penny stocks would be the better choice.

One thing I would note here is that penny stocks tend to attract low-capital traders because of their lower cash requirements. This is not a good reason to opt for penny stocks, though, because their lower liquidity tends to mean higher bid/ask spreads than in higher-cap stocks and commissions have a higher negative impact on a smaller account than on a bigger one. You will likely find if you are a very low capitalized trader that transaction costs in forex are smaller.

If you’re new to trading, my advice is to pick one or the other. Working on learning two quite different markets when you’re trading to develop your knowledge and skills will be problematic.

Picking a demo platform
In an ideal world, you’d go with the demo platform of the broker you plan on trading through when you go live. That said, part of the demoing process is also finding a broker whose platform you like. Also, if you’re planning on doing an extended period of demo trading you may be constrained by the time limits that some demo platforms have.

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.