11

Out of curiosity, I've casually followed some penny stocks that trade for under a dollar a share, and find occasional swings up of 10-15%. One naive interpretation of this fact is that if I bought $10,000 worth of these shares, and the stock went up 10%, and then I sold, I would make back $1,000 (minus my $8 trade fee).

But the daily volume of the stock is only around 50,000 shares. If we assume the stock trades at $0.20, my $10,000 would be a sudden purchase of that amount all at once. I alone would be causing the trading of a whole day's worth of shares. (If I could buy $100k worth of shares, it would be 10x the daily average, etc.)

My question is: How should one think about what the effect would be for a sudden purchase that "swamps" the usual trading volume? I have a feeling doing this would be a really dumb move, but I want to understand all the mechanics of why.

  • 5
    If the daily volume is 50K stocks, who do you think will sell you 100K? – littleadv Oct 7 '11 at 7:22
  • 3
    This is a decent question, because you can't easily answer it for yourself. Why? Because you can't paper trade pink sheets or penny stocks, not in the same (meaningful) way you can paper trade (as a learning exercise) with NYSE or NASDAQ listed stocks. – Ellie Kesselman Oct 7 '11 at 9:00
  • @FeralOink Also, can't I not virtual trade such low volume stocks with any useful return in knowledge since the virtual trade can't build in the result of my big-volume trade on the stock price? (Whereas a very high volume stock's price would never be affected from just my $10k buy order). – Chelonian Oct 7 '11 at 17:33
  • 1
    @Chelonian Exactly. That's why you can't "virtual trade" a low-volume stock under the circumstances you describe, because there's no (easy) way of replicating the real life market interactions. – Ellie Kesselman Oct 8 '11 at 0:11
6

The effect of making a single purchase, of size and timing described, would not cause market disequilibrium, it would only hurt you (and your P&L). As @littleadv said, you would be unlikely to get your order filled.

  • There wouldn't be anyone to take the other side of your trade,
  • There wouldn't be enough shares available at short notice, as a block.

You asked about making a "sudden" purchase. Let's say you placed the order and were willing to accept a series of partial fills e.g. in 5,000 or 10,000 share increments at a time, over a period of hours. This would be a more moderate approach.

Even spread out over the span of a day, this remains unwise.

  • You'll alert the few market participants in that stock that you have a large interest in buying.
  • You'll probably drive up the price of the stock, due to basic supply and demand for available shares.
  • You'll create the perception of a "story" or other change in fundamentals about the company, and expectations of share price appreciation in the near future. Even if it is true, you'll overpay, or possibly not be able to buy it at all, as existing shareholders won't want to sell if they think there is a chance for profit-taking.

A better approach would be to buy small lots over the course of a week or month. But your transaction fees would increase.

Investors make money in pink sheets and penny stocks due to increases in share price of 100% (on the low end), with a relatively small number of shares. It isn't feasible to earn speculator profits by purchasing huge blocks (relative to number of shares outstanding) of stock priced < $1.00 USD and profit from merely 25% price increases on large volume.

12

I've alway thought that it was strange, but the "price" that gets quoted on a stock exchange is just the price of the last transaction. The irony of this definition of price is that there may not actually be any more shares available on the market at that price.

It's also strange to me that the price isn't adjusted at all for the size of the transaction. A transaction of just 1 share will post a new price even if just seconds earlier 100,000 shares traded for a different price. (Ok, unrealistic example, but you get my point.)

I've always believed this is an odd way to describe the price.

Anyway, my diatribe here is supposed to illustrate the point that the fluctuations you see in price don't really reflect changing valuations by the stock-owning public. Each post in the exchange maintains a book of orders, with unmatched buy orders on one side and unmatched sell orders on the other side.

Buy         Sell
100 @ .20   50  @ .22
75  @ .19   80  @ .23
125 @ .15   100 @ .30
...         ...

If you go to your broker and tell him, "fill my order for 50,000 shares at market price", then the broker won't fill you 50,000 shares at .20. Instead, he'll buy the 50 @ .22, then 80 @ .23, then 100 @ .30, etc. Because your order is so large compared to the unmatched orders, your market order will get matched a bunch of the unmatched orders on the sell side, and each match will notch the posted price up a bit.

If instead you asked the broker, "open a limit order to buy 50000 shares at .20", then the exchange will add your order to the book:

Buy         Sell
100   @ .20 50  @ .22
50000 @ .20 80  @ .23
75    @ .19 100 @ .30
...         ...

In this case, your order likely won't get filled at all, since nobody at the moment wants to sell at .20 and historically speaking it's unlikely that such a seller will suddenly appear.

Filling large orders is actually a common problem for institutional investors:

http://www.businessweek.com/magazine/content/05_16/b3929113_mz020.htm

http://www.cis.upenn.edu/~mkearns/papers/vwap.pdf (Written by a professor I had in school!)

  • 2
    Great explanation. It's also somewhat important to note that some (all?) brokers let you choose to break your order up or keep it all together. – Nicole Oct 8 '11 at 2:42
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    If the share price was $0.90 a few months ago, someone might have optimistically put in a sell order for 5000 shares at $1.00 months ago. If that order was never filled, and is still in the system, and the price has badly dropped to $0.20, your 50,000 share order will eventually suck up that sell order and make someone very happy by giving them $5,000 for shares that were only worth $1,000.. – gnasher729 Oct 22 '15 at 23:48
  • @gnasher729 Your example illustrates exactly why the average investor should never place market-price orders. The average investor should use limit orders only. – Mark E. Haase Oct 23 '15 at 22:41
8

First, If you buy $10K of a penny stock and try to sell it that afternoon, you probably won't get your money back. The bid/ask spread may cost you dearly.

On the shady side, if you are able to afford to trade enough shares to attract attention, the interest of those who believe the volume is an indication of some real event happening, you may pump it high enough to make some nice money, selling into the ensuing rise. This is a classic pump and dump (which often but not always, includes posts on message boards) and it is illegal. The same way this volume attracts traders, it can also attract the attention of the SEC.

This should be read as a narrative, not as advice. If anything, it's advice on what not to do.

  • 1
    Really it depends on what OP does. And the SEC probably is not going to mess around with 10k or less in profits as the investigation will cost 25k. So unless the OP shows a pattern of doing this or the tell tale signs of a pump and dump (the message board posts, spam, etc) the SEC is unlikely to notice. Profit taking is not illegal but just as the buy order triggered buying sell orders trigger selling. Unless you are on the floor and able to make the trades yourself what you are talking about is really hard to pull off. – user4127 Oct 7 '11 at 17:21
  • I'm not planning on doing it, but how can a "pump and dump" in which one does not tout the rising value of a stock on the internet be "proven" to be intended to be unfairly manipulative? I mean, I was genuinely naively thinking that, "hey, I could make a nice $1,000 from the swing trading here" and wasn't intending to artificially pump up the stock price. And how much is too much "pump"? Sounds like quite a grey area. – Chelonian Oct 7 '11 at 17:26
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    @Chelonian - Too much is what the investigator says is too much. If you shake up a company that has a normal value of $0.60 per share and after your buy/sell spree the value ends up at $0.50 the company could ask for an investigation. But realistically what will happen is you will pay about .65 for the stock because that will be the cost to get the number of shares you want. You will end up selling it for .55 and lose .10 a share because the original owner will buy it back for that. And the stock will settle back at .60 shortly after. – user4127 Oct 11 '11 at 16:03
0

If you are the only one who puts in a large market buy order, then it would definitely push the price up. How much up would depend on how many would be willing to sell at what price point. It would also be possible that your trade will not get executed as there are no sellers.

The same would be true if you put in a large sell order, with no buyers. The price would go down or trade not get executed as there aren't enough buyers.

-2

It's illegal and you can go to jail because it exploits the small companies and their investors who believe in the company.

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protected by Nathan L May 17 '17 at 16:16

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