Understanding the Penny Stock Investor: Who, Why, and How

This is a contributor post.

Whether you are a seasoned or a first-time investor, you can’t deny being intrigued by penny stocks. Yes, they are the most speculative, and the odds of losing are pretty high. Still, millions of investors trade penny stocks daily. Ever wonder why?

Is it because they are confident about winning? Or is it merely the thrill of anticipating quick, substantial returns that keeps them going? No one knows for sure. But even if you can’t trade options for particular penny stocks, it’s possible to use options for significant leverage on small caps. That’s where understanding buy to open in options trading becomes vital to pushing the interest level in the market.

If you’ve been wondering what kind of investors actually invest in penny stocks, you’re looking at the suitable space. 

Investor Type 1: Seasoned Penny Stock Traders

The most successful traders are the ones who have carved a niche for themselves. Despite fewer traders, penny stocks undoubtedly fit the definition of a niche. These investors essentially belong to the class of traders who aren’t easily deterred by limited liquidity or fast-changing market prices.

Honestly, there’s no surprise left for them, no matter how volatile the market looks. They can be either day or swing trading and take short and long positions.  

Investor Type 2: Company Insiders

When individuals from the top management invest to buy a company’s stock, it’s usually a vote of confidence. However, when these corporate insiders choose to dump stocks, it means the firm has lost its way and that its stock price is on the verge of collapse. 

While this is a rule of thumb, it doesn’t hold water for penny stocks. Such company insiders are generally behind the manipulations that flood the penny stock domain. This is how penny stock got its “unreliable” tag as unscrupulous traders resort to “pump-and-dump” scams.

Investor Type 3: The Short Sellers

Ask any reputed trader, and they will tell you how they prefer short-selling when it comes to penny stocks. This is because there’s nothing to gain from buying and holding on to them. 

However, such traders are those who lack adequate capital and often rely on leveraging market intel to identify short-term opportunities. These are necessarily the shares whose value is set to decline faster. 

In other words, they refrain from contrarian investing and take to short-selling a rising stock, purely driven by promotional activities. Once the stock starts to shrink, they will keep their short positions open, hoping to make some profit.

Investor Type 4: The Broker-Dealer 

A broker-dealer or a market maker facilitates specific security trading by depicting bids and asking for quotations. They become significant contributors to overall trading volume in their attempt to boost liquidity in the penny stocks market. 

When a buy order is received from a trader, the broker-dealer either sells the shares from the inventory or buys them directly from the market to sell onward to an investor. 

On the flip side, when it’s a sell order, the broker-dealer would either absorb the shares into the existing inventory or dump them in the open market.

Investor Type 5: The Speculators

Here comes the lifeblood of the penny stock market. Speculators are those who have already profited from investing in penny stocks.

Before any major sale starts, a good amount of buying generally inflates the stock price. The lion’s share of these buying comes from long-term speculators. However, it’s only evident that one with a bitter taste in penny stocks will think twice before calling a shot. Yes! Penny stocks are a mixed blessing.

Investor Type 6: Newbie Investors 

Ten thousand shares of a 10-cent stock at just $1,000! Any newbie in stock trading would jump for that kind of deal. And, when that stock goes up to 15 cents, they have already made a fifty-percent profit in their investment.

Reality check: That kind of movement is uncommon in stocks. For the sake of argument, even if such shifts happen, limited trading liquidity prevents investors from making quick sales to close positions and lock their profits.

The Bottom Line 

Despite many lowdowns, penny stocks continue to attract people every day. However, it’s a game where the experienced will have an upper hand. So, if you are tempted to trade in penny stocks, you must make it a point to trade short-term until you build experience.