More & More Problem(s) with Penny Stocks.
Liquidity Giveth, and Liquidity Taketh Away
In regards to Trading, Liquidity refers to the ease with which one can buy or sell a security without moving the price (see “slippage”). A stock with an average daily volume of 10 million shares is much more liquid than one that only averages 10 thousand shares. So, the problem with penny stocks is that they typically don’t have high average daily volumes, lending itself to highly volatile price movement, and difficulty involving getting into or out of a position in them.
The sometimes insanely high one-day bullish percentage gains for a penny stock are often due to a HUGE influx of buy-side liquidity, which drove the price up… But it works the other way, too, and penny stocks can get driven down much further beyond a point where one might otherwise comfortably and calmly exit a position.
From a wider-scoped perspective, a lot of penny stocks simply do not have a large amount of publicly available shares (“Float”) and/or total shares issued (“Outstanding”). Looking at a history of volume and percentage gain leaders for the day, you will find Penny Stocks that trade a significant portion (sometimes multiples) of their Outstsanding Shares in a single day!
Volatility
A lack of liquidity is mainly due to a lack of regular market participants. This results in wider spreads than for a highly liquid large-cap company. You may see spreads that turn out to be a significant percentage of the displayed price, as well as “last trade” quotes that might be further away from the current bid/ask than you might normally expect.
As such, these conditions lead to volatility, where prices seem to jump around even though the net change over a longer period of time may be rangebound. Some may view this as an opportunity, but the associated risk of attempting to profit from it is VERY high. Penny stocks can have extended periods of inactivity, and have extremely volatile price movement as participants move in and out of their positions.