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A Look at Penny Stock Volume


Hey this the smart money?


There are an untold number of ways to speculate in the stock market.

You could buy far out of the money call options, hoping a stock gets bought out. Or you could leverage your account and sell short S&P futures, counting on a market crash. Either way, essentially what you're doing is buying a lottery ticket with slightly better odds. One of the most time-honored speculative endeavors, though, doesn't involve leverage or margin.

Today we're taking a look at penny stocks.


Penny stocks go by several different names, such as Micro Caps, Bulletin Boards or Pink Sheeters, depending on how old the person is that is talking about them. They've been around forever, and are simply those stocks that have publicly available shares but the companies do not meet the listing requirements of major exchanges like the New York Stock Exchange or the Nasdaq National Market.

Typically these shares are very low-priced, usually under $1 (thus the moniker "penny stock"), but not necessarily so – some trade at prices as high as $5 or even $10. Most brokers allow you to trade the shares with no special suitability hurdle, though some do require such a thing. The stocks tend to be extremely illiquid and are a hotbed of pump-and-dump and other stock manipulation schemes. It is an area best avoided by nearly everyone.


Listed companies are not exempt from corporate fraud, as we've seen ad nauseam over the past few years. But the companies are higher-profile and the investors tend to have more at stake in terms of fiduciary duty. Just by the virtue of being listed, most of them have higher volume and are thus less likely to suffer from stock manipulation raids.
So when we see investors concentrate on stocks that do not enjoy those benefits, and instead have a high degree of risk on several different levels, we can conclude that there is a desire for speculation. Excessive desire to trade these lottery tickets should be a sign that things have gotten too far out of hand, and for the most part that tends to be the case – near market highs, we see extremely heavy penny stock volume, and near market lows that usually dries up.


By virtue of their unlisted nature, it's sometimes difficult to get reliable information about these stocks, much less the unlisted market in general. The information we are provided by the OTC Bulletin Board quotation service seems to be reliable, but it is released only monthly and the reporting schedule has been wildly erratic.
Like most other equity market data, there are long-term trends in volume. While some month-to-month changes are obviously out of place, a gradual increase in penny stock volume is normal and adjustments should be made for the secular trends in the data.

The most recent data released, covering trading through February, shows an incredible jump in trading volume in these lottery tickets. There were over 105 billion shares traded last month, nearly twice as heavy as the previous record set in January 2004.
This was not due to one or two stocks – the top 10 volume leaders last month made up only 4% of total volume. The interesting thing is that the dollar volume traders committed to these stocks did not show a similarly astounding spike – this can only mean that traders went down further on the price scale.
Last month, the average price per share of trades on the Bulletin Board was $0.043. This is a new record low, going back to 1995, with the previous record being $0.062 in June 2004.

Perhaps because we're not seeing a high monetary commitment to this market, one could say that speculation is not as overdone as it was periodically last year or during the bubble days. But my contention would be that seeing traders go out further down the price scale is not a good sign. Each of the three previous volume spikes we saw in 2004 and 2005 resulted in an average 7% decline in the Nasdaq Composite over the next three months, further bolstering the idea that such speculative fervor is not a market-positive development.
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No positions in stocks mentioned.

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