How Penny Stocks Work

| April 5, 2012 | 0 Comments

The stock market is a great way to save money. Typically appreciating faster than the rate of inflation, the stock market is one of few places that one can put money for the long term without it losing value. For some investors though, the stock market is more than a way to save and earn a little interest; it’s a source of significant income.

In order to leverage the stock market as a money-making device and not just a money-saving vehicle, some advanced strategies are needed. One of these strategies is short selling. An investor borrows a share and sells it in hopes that the price will drop, and then buys to cover at the new, lower price, making a net profit of the difference between the original price and the bought price, minus the cost of borrowing.

Penny stocks are also used to gain money over the short-term. Often an owner of a small company in an emerging market will put out an IPO simultaneous with a press release detailing likely future expansions, growth and profits. Then, the owner will buy a large percentage of his own stock, which sharply lowers supply. The drop in supply combined with the positive reviews for the company in the news (which might not even be an actual company), drives up demand and price.

Other investors get on board, buying up more shares and driving the price up astronomically. When the shares have gone up sufficiently, the owner sells, which floods the market with available shares. This sudden increase in supply drives demand down and the price begins to drop. The other investors realize the increase in price was artificial and also begin to sell, and the price plummets. Many of the investors will not be able to get out in time and lose everything they invested as the stock drops to zero.

It’s possible to do this with penny stocks because they are not regulated as tightly by the SEC. While this is certainly a real possibility, many penny stocks are actually a good investment. Good penny stocks to buy are those attached to companies that can be researched extensively, and which show a legitimate track record for growth.

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Category: Penny Stocks

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