Understanding the Differences Between Larger Stocks and Penny Stocks


By now you have probably heard hundreds of stories from penny stocks traders about hitting a big-time payday after following a hot tip. Those hot tips come because penny stock traders understand the difference between the larger stocks and penny stocks. If you’ve turned your eye towards investing and you’re approaching it from the mindset of trading blue-chip stocks like Apple and Facebook, keep these quick tips in mind.

Understanding Economies of Scale

Large companies that have more resources and capital at their disposal can weather both good and bad news based on sheer brand presence alone. Penny stock companies have no such luck, as so they must focus on being a niche product or service within the broader category. Many pharmaceutical and biotechnology stocks fit into this niche category because they are focused on treating a specific disease or disorder. This niche focus also means these stocks can be much more volatile due to lousy news arriving. Since penny stocks are typically traded at much lower volume than common blue-chip stocks, you need to be hyper-aware of the news cycle surrounding your investment.

Driving Headlines vs. Fiscal Outlook

When picking blue-chip stocks to invest in, you look at the fiscal outlook for the company over the next few quarters to see if you believe the company has room to grow. That’s harder to do with penny stocks since most companies are not profitable and will not be for years. Investors in penny stocks often ignore fundamentals surrounding penny stocks in the hopes of striking it big if the company’s product or service becomes integral to society. For example, Facebook’s IPO in 2012 was thought to be a failure after the stock peaked at $38 and then dropped back down to $25. Now Facebook shares are worth $181 and climbing thanks to becoming one of the world’s biggest advertising platforms.

Be Aware of Broker Policies for Penny Stocks

Because penny stocks are often considered a risky investment, you need to be aware of your broker’s policy towards them. Any stock that trades for a price less than $5 per share is considered a penny stock by definition. Usually, brokers make these stocks not option eligible, which means you cannot short them, buy on margin, or set up stop loss orders. Beginning traders won’t need to worry about those options, but more experienced traders who are want to dive into the world of penny stocks should keep this rule in mind when selecting a broker. Some brokers don’t even allow limit orders for these stocks, which can severely impact your trade performance.

Understand your Projected Length of Investment

Traders who buy blue-chip stocks do so to keep their money growing with the market. Traditional stocks like Ford and Visa are bought and held in a portfolio that matures over the course of years to decades. That’s because these companies are considered financially sound and their products or services an integral part of society. Penny stocks are traded and held on a much shorter length, sometimes only days to weeks at maximum. In fact, it’s not uncommon for penny stock traders to engage in a small-form of day trading, especially to take gains off the back of good news. Penny stock investments should be made according to a much shorter timeline compared to traditional stocks, and this can be the most significant barrier to succeeding for new traders.