As a beginner trader one of the toughest decisions to make is choosing your niche. Your time window you choose to trade in, the assets you want to trade, the broker you want to use, and more.
One of the hardest decisions a stock trader has to make is if they choose to trade penny stocks, or higher priced stocks. This can be especially difficult for traders who intend to use small accounts.
Below I am going to list the pros and cons of both penny stocks, as well as higher priced stocks.
Pros of Penny Stocks
- Cheaper Shares. This is most likely the biggest reason why many traders decide to trade penny stocks. The cheaper the stock, the more shares you can buy. The more shares you have, the less of a dollar value move the stock needs to make money. For example;
2 Traders (John and Jenny) have $2,000 Accounts each. John buys Stock “EFG” for 1000 shares at $1. Jenny buys Stock “ABC” for $20 shares at $50. If both stocks move $1…
John just made $1000, but Jenny only made $20. This is primarily due to the percentage move that just happened.
Both stocks moved 1 dollar, but the stock that John traded just made a 100% move, vs Jenny’s stock which made a 2% move. This directly leads to the second pro of penny stocks..
- Bigger Percentage Gain. Penny stocks unlike other higher priced stocks are much more likely to see 50%, 100% even 200% gains if the right market conditions are among us. It is much easier for a stock to go from $1 to $2 than a $50 stock to go to $100. This is typically because a lot of smaller priced stocks have smaller floats. People are aware of this and try to take advantage of the possibility of a big percentage return. Bigger percentage moves X More shares = More profit
- Faster Moves/More Explosive Moves. This is referring to how fast the shares will often rise. In the chance that a $50 stock does go to $100, is will usually take some time for that to happen. Usually “bigger floats” require more volume to make the moves they need to make. For the same percentage move on a one dollar stock, its not uncommon that the stock can hit that 100% move in the same day. Simply because of all the attention it attracts being so cheap, plus not requiring a massive amount of volume to move.
Cons Of Penny Stocks
- Extreme Volatility Can Be Your Enemy. While volatility can be your friend if the stock is in your favor, it can be your worst nightmare when it goes against you. For the exact same reasons that make a lot of penny stocks do insane moves ( small float, cheap shares, more attention), these things will work against you when the stock turns the in the other direction, especially if you are longing (buying) these stocks.
- More Commissions. Depending on the broker you use, buying lots of shares can cost you a lot more in commission over time. The broker that I use charges about $5 per 500 shares (buy 500 shares + sell 500 shares = $5). This means to buy 2000 shares of a cheaper stock, it would cost me a total of $20 dollars. Yikes. Compared to if I bought and sold 200 shares of a higher priced stock, it would only cost me a grand total of $2 . With that low of a commission, I wouldn’t even hesitate to get in or out. However, when you have higher commissioned pricing, you start to hesitate because you most likely don’t want to lose that $20 , just to try and get back in later and spend another $20. *This most likely does not apply to brokers who have a flat fee for commissions
- Halts Happen More Often. In penny stocks, because they have the tendency to make huge moves in such a small amount of time, they are often halted by the sec for small investigation. Halts can take place for 5 minutes, 10 minutes, 20 minutes, all the way up to months. I’ve personally witnessed traders who have been stuck in a halt that lasted over month. Imagine your hard earned money being tied up, not knowing when its going to be released, if at all. As well as you not knowing the price the stock will open up at, its a huge risk some traders are willing to take.
- More seasonal/ Periodic. The penny stock world is known for droughts or hot and cold streaks that can last for awhile. Obviously the entire market fluctuates throughout the year, but for the most part there will always be higher priced stocks in action because of how many there are as well as the price ranges. I consider higher priced stocks to be priced between $10 and $300. Obviously there are higher priced than that, but the majority seems to be within that range. With penny stocks, you could have incredible moves for 3 months, but then barely anything for 6 months. This is fine for a trader who doesn’t mind that break, but the most of us prefer something a bit more consistent.
- Less Trustworthy. Penny stocks are usually penny stocks for a reason. The lower price indicates to me there value, as it should. There is a reason why Google, Apple, Amazon and Netflix prices for there stock are on the high side. Because of the cheap prices of penny stocks, traders must be careful of trying to hold them overnight. Penny stocks have a much higher chance of being desisted than higher priced stocks, or losing the majority of its value overnight. In no way am I saying that bad news or bad situations can’t happen to higher priced stocks overnight, but i would definitely be more skeptical about holding penny stocks overnight.
Pros Of Higher Priced Stocks
- Less Commission. Depending on the broker you use, trading higher priced stocks with smaller size with cost you less over time rather than buying or selling tens of thousands of shares. Some brokers do charge on a trade by trade basis with a fixed rate, so in that case it will not matter how much shares you use. But if you do have a broker that does charge based on share size, then it will be beneficial to trade higher priced with less size because you can get in and out of a trade whenever you see fit.
- More Trustworthy To Invest In. Higher priced stocks can often be actively traded as well as invested in because of the trustworthiness of the company behind it. Stocks that are higher priced are usually priced that way for a reason; because the company has value. You might not ever see Amazon or Google just disappear overnight like a lot of penny stocks do. Yes there are higher priced stocks that will have bad news and will lose 10%,20%, 30%, but in my opinion it is much less likely to happen in the higher priced region verses the penny stock world.
- Moves Are Slower. Now, some traders are going to think this is a bad thing. Well it depends what your tolerance is. There are traders that love the super fast spikes and dips in a stock, but that requires a lot of patience and quickness at the same time. There are other traders who prefer to allow there position to calmly go in there favor. Slower moves means that you have a heightened ability to stay relaxed through certain moves, unlike a lot of penny stocks where they can be so volatile that they shake you out of the position before the move even got started.They don’t mind if it takes hours, or days for their target to hit, they will gladly sit through it and prefer it that way.
- All Year Round. About 3 out of 4 stocks follow the overall market and these and to be more higher priced stocks. Unlike the penny stock world that seems to be steaming hot one month and then completely absent the next 2 months, the higher priced stock world has more consistency behind it. That doesn’t mean that they are always going up. It could be a bearish market, but even then it often means there will be something to play on the short side. All markets will also also have a dip in volume around the summer time but even then, there are usually still higher priced stocks to play, just not as much as there were during September to march.
- Halts Less Often. Halts happen less for higher priced stocks for one major reason; They rarely ever have those huge explosive percentage moves that the penny stocks have. Remember, a $5 dollar move on a $1 dollar stock in 2 minutes appears to be way more suspicious to regulators than a $5 dollar move on a $50 dollar stock.Its not about the dollar increase, its about the percentage move that will often trigger the halt.
- More Range. This sort of makes up for the lack of explosive moves that the penny stocks tend to have. Traders are often under the illusion that when you buy higher priced stocks that the profit potential is no longer worth it. I am guilty of thinking that way as well in my earlier days. The truth is that high priced stocks have tremendous range since they are higher priced in the first place. Remember 5% on a 1 dollar stock is only 5 cents, but on a $50 dollars stock 5% is $2.50 dollar move. If you ask me, I would rather put 100 shares into a $50 dollar stock($5,000) and try to get the $2.50 dollar move to make $250 rather than putting in 5,000 shares into a $1 dollar stock ($5,000) and hope for a 5 cent move to make that same $250 dollars.
Cons of Higher Priced stocks
- Higher Priced Stocks Require More Money. This is the only real downside I see to trading higher priced stocks. Since they are higher priced, you need a higher amount of money. Now, what I did (And i’m not recommending it) was use margin. There going to be traders who will tell you don’t, but when i am trading 100 shares of a stock on margin, you can easily manage your risk compared to you using margin on a penny stock. I would recommend that you NEVER USE MARGIN ON A PENNY STOCK. It is much harder to manage with a high amount of shares, High volatility, as well as increased risk for a halt. This is not advice telling you to use margin however.
At the end of the day, you have to choose what decision is best for you.