Blog : Life in the Fast Lane

by Ed Zwirn on March 22nd, 2013

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Time was when investors in penny stocks as well as stakes in larger companies would put money into shares of these companies and hold onto them for years in the hopes of getting dividends. In the past century, this has been replaced by more rapid turnover as the grandchildren of these investors bought and sold stocks to make money on share price increases.

And with more and more of this trading, currently an estimated 73% of total stock market volume, being conducted using algorithms, dark pools (if they sound scary, that's because they are) and high-frequency automated systems, the frequency with which shares turn over in the market is on a rapid rise.

It has been estimated that at the end of the Second World War, the average holding period for stocks was four years. By the turn of the millennium, it was eight months. By 2008, the average holding period declined to two months. And it has been estimated that, at least for actively traded shares, it had declined to 22 seconds by 2011, Wallace Turbeville writes in Demos, a public interest website.

The most frightening example of how this increase in stock turnover has impacted the market occurred on May 6, 2010, when computer-driven trades caused the Dow Jones Industrial Average to plunge over 1,000 points in a matter of minutes. Clearly, while penny stock investors are only indirectly affected by wild swings like this one, a more volatile situation means greater possible risks (and rewards) for all.

Ironically, the latest trends may in fact be lessening the difference between the risks of investing in penny stocks and stocks of larger companies. Penny stocks, to the extent that they trade at all, are, after all, less likely to see their volumes go up and down based on programmed trading. The volume swings for a penny stock may be very sharp, but these swings are usually driven by events that impact the company rather than automated flows of huge amounts of money.

Of course, the evidence seems to show that penny stocks, because they thrive when investors have more money in their pockets, seem to gain in general, but after a lag, whenever the broader market is rising. And, because this probably holds true in reverse, penny stock investors can be helped or hurt by the much faster pace and greater volatility of the past few years.