Specific Factors Driving the Prices of Penny Stocks

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When it comes to low-priced shares, most investors believe that stock prices are moved by corporate earnings, acquisitions, new customers, or huge contract wins. And it's true that these influences can have an impact. But there are a whole host of other factors that can drive the prices of penny stock companies.

In fact, many of these influences are often overlooked, ignored, or misunderstood. The price drivers we will consider here are not the "be-all and end-all" of stock market success. However, they can go a long way in lifting you toward the next level.

Look at each and every factor that you possibly can once you've decided to wade into the penny stock waters. If you are considering trading in a low-priced investment, your results will be directly proportional to the amount of work you commit to your analysis.

Unfortunately, most investors simply do not go deep enough. Since penny stocks are typically smaller and more volatile companies, it doesn't take a lot to derail them or throw them off course. And it also doesn't take very much to drive the prices higher. This all means that you need to be on top of your game.

Be sure to learn more about the factors that are really driving prices. In many cases, you might be a little surprised. So let's dive right in. Below are a few of the less obvious, but just as equally important, price drivers that will throw around the shares of low-priced stocks.

Key Takeaways

  • Because penny stocks have fewer shareholders, it is easy for buying and selling activity to become imbalanced. This causes prices to fluctuate.
  • Corporate growth on more than one front, such as rising revenues and an expanded workforce, often leads to an increase in share price.
  • Growth or contraction in an industry as a whole can lift or topple share prices. This is true even if the specific company's value hasn't changed.
  • Changes in returns for more stable stock, or more media attention, can cause investors to put money into riskier penny stocks, raising their prices.

What Is Technical Trading Imbalance?

In some cases, there is just too much buying compared to the selling or too much selling compared to the buying. Often, these technical imbalances are not even related to the operations of the underlying company. But they can still happen due to chance or the timing of investors.

This becomes especially true with penny stocks. That's because lower-priced shares typically will have fewer buyers, or they will have fewer sellers, at any given point. This thin trading activity can often result in significant technical imbalances.

Here's an example. Let's say there's a raft with 10 people on it. The raft may float fine much of the time, but at some points, there might be too many people all on one side...causing the raft to tip.

The same theory holds true with any thinly traded stocks. On average, maybe $5,000 worth of shares trades hands on any given day. But then, someone dumps $22,575 of the stock in one minute. In that case, that penny stock would suffer a technical imbalance.

In our example, there probably wouldn't be enough buying demand to hold shares up, beneath the weight of someone selling $22,575 worth of the investment. The share price would tank until the selling was absorbed by the buyers. 

Eventually, when a technical imbalance gets absorbed over time, the shares often move back to where they were in the first place. Whether it takes minutes, days, weeks, or months, the penny stock usually rebounds to former levels.

Note

Technical imbalances are—by nature—usually temporary and artificial.

There are many temporary technical imbalances. Astute investors might spot sudden selling activity. They may be able to capture a small position at a deeply undervalued price.

It can be difficult to predict potential imbalances. And it's equally tough to profit from their arrival. However, it is possible. For example, many stocks are more prone to technical imbalances because they are more thinly traded. This can also be because they have experienced such situations numerous times in the past.

When a little bit of buying demand drives up the share price, or perhaps a small amount of selling demand pushes the stock price lower, those who are wise will be watching how the stock trades. If the shares are very thinly traded and prone to technical imbalances, it may make sense to enter trade orders well below the current market price.

On the other hand, it may also make sense to set your sell orders higher than the current trading price. At any point, buying could cause the shares to drive higher simply due to a temporary technical imbalance.

What Is the Impact of Corporate Growth?

You want to see growth in as many aspects of a company as you can.

When a company sees their revenues increasing, and/or their earnings rising, and their market share ballooning, while their customer base expands along with their profit margins, the share price will almost certainly follow suit. This is truly a picture of the whole being worth more than the sum of the parts.

By this, we mean that while a single aspect of growth may result in the company increasing in price, when you see that growth appearing on multiple fronts at once, the positive results will be multiplied. Typically this means that the company is going to expand quickly, taking its share price higher on the way.

Sector or Industry Expansion

When a company is engaged in a growing sector or industry group, it's kind of like having the wind at their backs from an operational perspective. Let's say a business is bringing in 2% of the market share for a certain business concept. If that market doubles in size, the business may see a doubling in its revenues. And this is without even doing anything extra.

This is likely true even if their market share remains set at exactly the same amount—which is 2% in the case of this example. In a perfect world, you'd see the company in question claiming an ever-expanding percentage of the total market, while at the same time the total size of that market also expands.

Said another way, owning shares in a growing company is great, but it is just as good when the entire sector or industry group is expanding also. In fact, it's very forgiving in the sense that when the industry is growing, the underlying business can look like they are expanding and getting bigger regardless of how well they are doing in relation to their competition.

Tip

The best-case scenario is to find a small penny stock company that is capturing a greater percentage of the total share over time, while the underlying market is also growing. It is also the secret to long-term success in speculative investing.

Search for Returns

As stock markets go up, money managers get pretty excited because their shares are probably doing quite well. At the same time, investors get addicted to easy returns or the big gains they have been seeing. What typically happens is that these investors continue to look for even better returns. Or, they look to at least maintain the types of gains they have been getting used to.

As the profits from their earlier investments slow down a little, they will start looking downstream for other investment channels which could bring back the days of the big returns. For instance, let's say a stable blue-chip investment is returning 8% for a couple of years. Then, it starts rising by only 3% for the year. At that point, the shareholders and investors might look for something a little bit riskier, but with bigger return potential.

They will keep getting involved in riskier assets in their search for that 8%. They may look at penny stocks among other things. The aging of a market rally typically leads to more interest (and money flow) in speculative assets.

Said another way, in this chase for yield or gains, investors become more open to riskier investments. When a bull market in the broader exchanges and blue-chip equities starts to decrease slowly, a lot of money will find its way down to the shares which trade in penny stock territory.

As that money flow moves into low-priced stocks, the buying pressure can lift the share prices higher. This is especially true with thinly traded penny stocks, which can often be driven up pretty significantly in price with even the most modest amount of buying demand.

Media-Driven Hype

The media loves a good story: whether it's Bitcoin, Pokémon GO, or electric cars. When the coverage is keeping viewers engaged and coming back, they double down on that topic. What happens, as we saw with other penny stocks and digital currencies in recent years, is that the endless media coverage drives many investors into the concept.

Marginal or less-experienced investors will follow trending stories, thinking that if it's on TV, it must be a good investment. That could not be further from the truth. Remember: By the time the story is being splashed all across major media, the opportunity for investors is typically already long gone.

Summary Price Drivers

Most of the price drivers discussed above will not be present in a penny stock at most times. But there will be some moments when they come into play. It is in those moments when the shares may be able to be bought at a discount or sold at a great profit.

Being aware of the factors which are truly moving the prices means that you will be open to more opportunities than almost all other traders. Through awareness, you will have clarity. Through clarity, you can make better buying and selling decisions. Keep in mind that the price drivers discussed above can apply to blue-chip and large-cap companies, just as much as they do with penny stocks. Of course, the impacts and opportunities will be greatest when they affect the tiniest investments.

After all, the smaller something is, the less energy it takes to move it. When a few thousand dollars of buying or selling can move the price of a stock, you will see that events like media hype, technical imbalances, and the other factors discussed above all have an outsized impact.

A massive corporation like IBM can have a technical imbalance. But it will typically be much smaller and short-lived than one which affects a tiny company. That is why the best opportunities can always be found among penny stocks. Just be sure you understand what is really moving the price.

What Are the Risks of Penny Stocks?

Remember that there are risks involved in penny stocks, as well. In many cases, there are more risks with penny stocks than there are with other types of stocks. These risks include:

  • Low liquidity: You may find pricing that shows an imbalance. But trying to trade in and out of a position may be costly due to larger big/ask spreads.
  • Lack of transparency: The companies that issue penny stocks may not be up to date on their financial disclosures. Large, blue-chip companies are much more likely to have current financial disclosures.
  • Manipulation: Due to the nature of penny stocks, they are more susceptible to fraud such as "pump and dump" schemes.

The Balance does not provide investment advice. Penny stocks are considered speculative with high risks of loss of principal. This article should not be considered trading advice or a strategy for retirement savings. Please speak with a financial planner regarding investment strategies.