Are Penny Stocks Creating A Bubble Or New Buying Opportunity?

A Surge In Buying Has New Traders Focusing On Stocks Under $5

Whether you’re new to trading or an experienced pro, penny stocks are something you’ve probably heard of or read about. Right now, these cheap stocks are becoming all the rage. I’m talking about those cheap stocks that have been dramatized by movies and TV shows. They usually depict high-energy traders making millions of dollars in the blink of an eye.

I’m not talking blue-chips here; these are stocks of companies that not many have heard of. They’re also companies that aren’t well-established, and some are even distressed. With the advent of COVID-19, rising unemployment and mandatory stay-at-home orders have created a unique situation. People are bored in the house and in the house bored looking for ways to make money.

“Maybe no sports is playing into this, but the real contributors are time, ability to focus with less distractions and people’s desires to improve their condition.”

JJ Kinahan, chief market strategist at TD Ameritrade, said in an interview

Technology is a beautiful thing. With mobile-based penny stock trading apps like Robinhood and WeBull, accessing the stock market couldn’t be easier. Robinhood, in particular, has helped pave the way for traders to make money with stocks right from their phones. The app has also rolled out new pricing, which includes a no-fee model.

Because of the growth in Robinhood’s userbase, other brokers like ETrade, TDAmeritrade, WeBull, and others have adopted this no-fee model. So, as a new trader, what is the excuse? With just a few hundred dollars, you can start making money, and penny stocks are perfect for leveraging small sums in return for significant gains, right?

The Growth Of Penny Stock Brokers During COVID

Zero-commission trading and a little boredom have attracted a whole new group of investors. These aren’t sophisticated Warren Buffett-types. We’re talking average Joe’s with a bit of cash and dreams of hitting it big in the stock market. It isn’t just a “Robinhood” thing either.

coronavirus penny stocks to buy

Charles-Schwab clients opened a record 609,000 new brokerage accounts. Over 280,000 came in March alone, according to the company’s most recent earnings report. Net new accounts for Etrade also surged during the first quarter. The broker credited for revolutionizing electronic trading reported over 363,000 net new accounts. That’s a jump of nearly 170% from 2019’s first quarter.

But the shining star here is Robinhood. The mobile broker posted a record 3 million new accounts in the first quarter. This looks like a clear sign of where new traders are focusing right now. Where the app lacks in analysis tools, it gains in ease of use, especially for younger “millennial” traders.

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“The equity buying spree by the Robinhood community garnered a lot of attention recently and raised concerns about misplaced euphoria among ‘rookie’ investors,” wrote Emmanuel Cau, an equity strategist with Barclays. Is this rampant, unbridled buying creating a bubble, or is it carving out an entirely new way of investing in penny stocks?

Perfect Timing To Buy Penny Stocks?

To understand this, we don’t need to look far. Inexperienced traders are thirsty for quick gains in place of doing hours of research. They’re investing their money in 3, 4, or 5 letters instead of actually seeing the fundamentals or even the company name. This trading style has created its own problem for traditional investors and a substantial short-term buying opportunity for today’s average Joe retail trader. Penny stocks have certainly gained ground during this time and likely will continue doing so.

With these traders buying up shares of bankrupt companies like Hertz (HTZ Stock Report) or J.C. Penney (JCPNQ Stock Report), the traditional ideologies behind investing are out the window right now. There are also billions in stimulus funds getting injected into the hands of Americans right now. “This all amounts to what seems like a retail short-squeeze feeding frenzy that has reached blow-off top proportions,” Citadel Securities said in the note. 

Outspoken pizza critic and sports better, Dave Portnoy, founder of Barstool Sports, has also gained acclaim for his inexperienced means of making money with penny stocks. He told CNBC, “We are ‘Barstooling’ it, we are making hype videos, we are getting behind it, we are live-streaming it. And I think a lot of the old-time guys just don’t know what the hell is going on with us so they don’t know what to make of us.”

With the volatility in the market, average traders are now seeing that you don’t need higher education to make money with penny stocks. Hertz, for instance, saw famed investor Carl Icahn dump his entire position earlier this year. Shortly after that – as shares traded as low as $0.40 on May 26th – “gun-slinging” penny stock traders started to buy up shares of the bankrupt company.

Are Fundamentals Out The Window?

Completely ignoring the economics of bankruptcy, these traders were in it for the quick flip, and Hertz shares rose to highs of $6.25 on June 6th, over 1,400% in just a few weeks. While the penny stock plummeted back down below $2 almost immediately after, the event itself clearly showed traders could make money with penny stock no matter the state of the company itself.  So is this perfect timing to buy penny stocks?

Assuming the market will eventually find its footing, that answer is yes. Whether it’s a year from now or a few months from now, the stock market will likely settle down. Buying penny stocks during volatile markets is preparing new investors for learning how to trade them when things aren’t as unpredictable overall.

At the end of the day, if broader markets aren’t as exciting, you’ll likely see small-cap and micro-cap stocks gaining appeal as they’re well-known for increased volatility. Before this surge of trading interest, I think investors may have been intimidated by stocks in general. But clearly, we’re seeing not thousands but millions of new traders getting their feet wet in the market.

How can you fault them? Look at what happened this week with yet another massive breakout. Shares of Equillium Inc. (EQ Stock Report) barely trade. In fact, some days EQ stock has traded less than 10,000 shares. Everything seemed status quo going into the weekend. EQ closed out last week at $3.19 after a “busy” 48k share day.

best penny stocks to buy Equillium Inc. (EQ stock chart)2-Day Chart, EQ Stock

Before the market opened on July 13th, the company announced that a clinical trial conducted in India by its partner, Biocon Limited, demonstrated that its drug candidate itolizumab significantly reduced mortality in patients hospitalized with COVID-19. By the end of the day, EQ stock had jumped to more than $31 a share shortly after the closing bell and with more than 96 million shares traded. Yes, an 871% move from Friday’s close to Monday’s close.

Penny Stocks Outperformed The Stock Market

There’s no doubt that the stock market has mounted a massive recovery since dropping in mid-March. But there’s a glaring outlier that supports the strength of smaller stocks. The S&P 500 ETF “SPY,” for example, has bounced back from lows of $218.26 in March to highs in early June of $323.41, a 48.2% jump. That’s not a small move whatsoever. But then when you look at something like the Russell 2000 ETF “IWM,” it’s clear as to which group of stocks have performed the best.

penny stocks S&P 500 SPY

The Russell 2000 is a subset of the smallest 2000 American companies that make up part of the overall Russell 3000 index. While it’s not a window into all penny stocks, it gives an understanding of how the broader small-cap companies are performing. In this case, the Russell 2000 climbed from lows of $95.69 in March to highs in June of $153.39, a move of 60.3% during that time. We can quickly see how strong penny stocks moved thanks, in part to new traders flooding in to make money.

penny stocks to watch Russell 2000 IWMThere Are Risks With Penny Stocks

This shouldn’t be a reason just to go out and follow some random person on social media. Volatile stocks include much higher levels of risk. For example, Hertz saw a 1,400+% rally in just a few weeks, that’s true. But shares also dropped by more than 80% within days of hitting its high.

[Read More] 4 Penny Stocks On Robinhood & WeBull To Watch Under $4

As they say, knowledge is power, and learning how to trade penny stocks will become even more critical. Now, millions of new traders are looking to top penny stocks to buy. Learning how to do that is more important than following a Twitter feed. In that case, education and learning how to become a consistently profitable trader will stand out.

Penny stocks offer a unique scenario. Traders of all walks can buy thousands of shares for a few hundred dollars at times. They can leverage the low-priced equity’s ability to move up just a few pennies and equate that to significant percentage gains.

In my opinion, if you can handle risk, penny stocks are one of the top ways to turn a small account into a larger one in less time. But you should learn how to trade, where to find relevant information, and understand how catalysts can impact these cheap stocks.

Are Penny Stocks Creating A Bubble Or A New Buying Opportunity?

Concluding this, it’s essential to get a grasp on what’s going on. On the one hand, we’ve got a surge of new traders coming into the market during a time of heightened volatility. They’re buying shares of worthless companies, forcing the hands of traditional investors. On the other hand, many of these traders have no clue what they’re buying. Nor do they have a keen understanding of how to trade, in general. The stock market has become the world’s newest casino in some respects.

However, assuming that these millions of traders will stick with the market, it may create a new way of trading entirely. Furthermore, speculation will likely take a more prominent seat at the investing table. This type of momentum-based trend was a bit taboo and “meant for penny stocks”. But now it could start to come to the mainstream a bit more.

Thinking back to other “bubbles,” we can look at the internet or “dot com” bubble of the late ‘90s. Investors flocked to these names without knowing much more than “this is the cutting edge of [insert industry here.” 

“This is not 1999, at least not yet,” DataTrek Research recently said in a blog post. “Yes, there are echoes. But the Google search data shows the rush of new investors/traders is already waning. Once sports betting comes back online, we suspect it will decline even further.”

Another round of new coronavirus records was hit in the U.S. this week. Therefore, the opportunity created in the stock market today won’t likely be fleeting. That’s at least as far as this year’s concerned. Is it time to lace up your running shoes, open a trading account, & start looking for penny stocks to buy?

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