Alton Hill is a Cofounder at TradingSim. He has a passion to help people and found that one of his ways of doing so, is through the world of Day Trading. Alton’s skillset is in Product Development and Design Thinking which he uses to write and improve the overall experience for TradingSim.
In this article, we are going to cover the top reasons penny stocks are viewed negatively in the trading community. After reading the article, see whether you still think penny stocks are the villain.
Table of Contents
#1 – Why Do Penny Stocks Have a Negative Connotation
If there is one area of the financial world that gets a consistently bad wrap, it’s penny stocks. Anything traded under $5 – $10 bucks is something many hoity toity investors would thumb their nose at as a purely speculative penny stock.
Whether they are pink sheets (OTC) or just the sub five buck stocks, penny stocks have an ugly reputation. And let’s be real.
Often that negative view and opinion is accurate. We also need to be aware that the first thing people think about when it comes to penny stocks is that they are a ‘scam’.
You can thank movies like the Wolf of Wallstreet for continuing to create a bad image for penny stocks.
Half of the reasons why penny stocks have had such a bad reputation over the years is due to the adage: “A penny stock is worth a penny for a reason.”
Some stocks are valued pretty low for a reason. However, in today’s day and age we have access to a slew of information that the retail trader and investor never had. We have access to great technical and fundamental screeners like finviz.com.
We have access to great SEC filings and corporate info from insiderinsights.com or advfn.com Information that used to be privileged is now often free and available for everyone.
And we can use that information to find some real gems.
#2 – Manipulation – Penny Stocks Cannot Be Trusted
Manipulation. Big scary word. Retail traders and investors love to use the word manipulation, often as an excuse for their bad trades and/or decision.
We need to be aware that there are very large entities that want to control projects and/or companies before their competitors and public at large can get their hands on it. One of the ways that they can do this is to keep the price low – low prices have a perception of low value. But the individual really needs to take a little bit of a dive into why.
#3 – Biotechs – Are They Just Pump and Dump Stocks?
Take a company called BDSI (BioDelivery Sciences International). At the time of writing this article, the stock is worth $2.78. I guess that makes sense. It’s a small-cap biotech.
You’ve never heard of BDSI, it’s not some big name like Gilead. It’s just another sub $5 penny stock.
Heck, if you took a quick look over it’s performance over the past three years you probably wouldn’t even take a look at it.
Come to think of it, why would this even end up on your radar? But I bet your familiar with the opioid epidemic.
And what does BDSI specifically target? Opioid dependence in people who require chronic pain management. One of the drugs they recently got approved is Bunavail.
Bunavail Product Description
“BUNAVAIL® (buprenorphine and naloxone buccal film) is indicated for the treatment of opioid dependence and should be used as part of a complete treatment plan to include counseling and psychosocial support. Prescription use of this product is limited under the Drug Addiction and Treatment Act (DATA). BUNAVAIL is the first and only formulation of buprenorphine and naloxone for buccal (inside of the cheek) administration. BUNAVAIL was designed using BDSI’s advanced drug delivery technology, BioErodible MucoAdhesive (BEMA®), allowing for the efficient and convenient delivery of buprenorphine while potentially overcoming some of the administration challenges presented by the sublingual (under the tongue) dosage forms currently available. It has twice the bioavailability (drug absorbed into the body) of buprenorphine compared to Suboxone, the market leader in this category. As a result of the improved absorption of buprenorphine with BUNAVAIL, which is the direct result of the BEMA technology, plasma concentrations of buprenorphine comparable to Suboxone can be achieved with half the dose, which may help to reduce the potential for misuse and diversion and potentially lessen the incidence of certain side effects. (www.bdsi.com/bunavail)”
In layman’s terms, this is an opiate pain killer, but it also prevents the psychologically and physiologically addictive effects of opiates. Let’s face it: there are millions of people who suffer with chronic pain and who have become addicted to opiates. This drug can help those suffering with addiction while also addressing their continued pain management. That’s a pretty huge deal.
So, it makes sense why the combined institutional and insider ownership is greater than 50%. This thing is a ticking time money bomb.
APDN (Applied DNA Sciences, Inc) is another small cap company that is repeatedly beat down for really no good reason (well, sometimes good reasons). They have a very forward thinking and working technology called the SigNature DNA.
Basically, plant DNA is applied (sprayed) onto the object to tag it and prove its authenticity. Unless you’ve been living under a rock, you probably understand that DNA is irrefutable and unable to be copied – so it’s pretty darn easy to tell if something is the real deal if tagged with APDN’s SigNature DNA.
In fact, they already use this in the cotton industry. Cotton is a heavily counterfeit and shady industry. Studies have shown that when US ships cotton to China for manufacturing into clothing, there is a drop in the percentage of cotton in the returning materials.
APDN’s SigNature DNA has help put a stop to that by actually spraying and tagging the cotton itself. That’s just awesome. (www.apdn.com/press-releases)
#4 – Large Number of Short Interest
Penny Stocks – High Short Interest
One of the prime examples of a penny stock showing signs of ‘that doesn’t seem right’ is when there is a large amount of institutional and insider ownership but the number of shares short is extremely high.
What does that mean? It means that the company has something of significant future value and the big wig owners are actively allowing and encouraging people (or themselves through proxies) to short the heck out of that stock. They’ll continue to keep that price down until they are ready to create their own self-induced short squeeze and the conditions for the FOMO (fear of missing out) trade.
Getting in early on a short squeeze is one of the most profitable low risk trades you can take.
For those technical traders you will not find the setup reviewing short interest stats and income statements.
You will likely want to use a technique such as a ‘Bollinger Squeeze’. ‘Bollinger Squeeze’ is a term technical traders know all too well and is a way to forecast a big move higher before it happens.
But fundamental traders do something different: isolate companies that have a high percentage of the shares short, a.k.a the short float. You can do this on your own by using finviz.com using the following steps:
1. Go to FinViz.com 2. Click on the ‘Screener’ tab 3. You will then see a pretty ‘noisy’ series of rows and columns. In the third column you will see ‘Float Short’, click on the pulldown menu. 4. Select ‘Over 30%’ (or whatever value above 10% you want)
You will then see several stocks that meet the criteria for having a large percentage of shares short. I would suggest further filtering the selection by ‘Country’ and by ‘Market Cap.’ One of the first signs of an impending short squeeze is if any of the companies have had a significant up-day. If you find one, go ahead and squeeze those shorts!
#5 – Penny Stocks Do Not Have Dividends Right?
Yes – penny stocks pay dividends.
Now, I am a dividend fanatic. I especially love monthly dividends. When the stock market is going on a tear and equities keep gaining value, dividend stocks sit on the bench – that’s when I like to buy them. There are some fantastic <5$ stocks that offer monthly dividends (Full disclosure, I have positions and I am long on the following tickers):
It’s important to recognize that there is some truth to the adage: “A penny stock is worth a penny for a reason.”
But it’s important to understand that just because something is a penny stock, doesn’t mean it doesn’t have value or growth. We should always ask the question: why? Why is that stock valued so low? Is it due to poor management and bad financials? What is their deliverable? What is the current phase of their cancer curing drug? How much institutional and insider ownership is present?
And when you find the answers to those questions, you can certainly find a diamond in the rough.