What is the 'Stock Market'?
-The "Stock Market" is a term used to describe the mechanism that enables the trading of company stocks. The market is made up of several 'Stock Exchanges' such as the NYSE, Nasdaq, AMEX, and OTC. A stock exchange is where buyers and sellers come together to exchange their stocks.
What exchange do penny stocks trade on?
-Penny stocks trade on the OTC market. Previously there was simply the OTCBB (Bulletin Board), and the PinkSheets classification for typical penny stocks. Recently the OTC has restructured the market by adding 'Market Tiers' to the system. Here's a basic listing and description of those tiers from OTCMarkets.com:
OTCQX®
The OTCQX marketplace is the premier tier of the U.S. over-the-counter market. Investor-focused companies use the quality controlled OTCQX listing platform to offer investors transparent trading, superior information, and easy access through their regulated U.S. broker-dealers.
OTCQB®
The OTCQB market tier helps investors easily identify companies that are current in their reporting obligations with the SEC or report to a U.S. banking or insurance regulator. OTCQB securities are quoted on OTC Markets Group's quotation and trading system and some may also be quoted on FINRA's BB. See OTCQB Fact Sheet.
OTC Pink™
The bottom tier of the OTC market, OTC Pink is a speculative trading marketplace that helps broker dealers get the best prices for investors. OTC Pink has no financial standards or reporting requirements, but companies in this tier choose the level of information they provide to investors and may have current, limited or no public disclosure.
FINRA® OTCBB
This security is one of approximately 30 OTC securities that are quoted solely on FINRA's BB quotation system so market makers must use the telephone to make any trades.
Below FINRA BB there are also 'Grey Sheet/Grey Market' stocks that receive no quotation or trading services from the OTC Market or any other U.S. Stock Exchange. Trades are made directly through broker dealers, and can be extremely difficult to execute.
When is the stock market open?
-The stock market is normally open Monday-Friday from 9:30am-4:00pm eastern time. There are extended hours in the morning and afternoon, but these don't apply to penny stocks trading on the OTC Markets. Most holidays result in closed, or "half" days.
What is 'Stock'?
-Stock is a financial device that companies use to allow people to buy a portion of ownership in that company. A 'share' of stock is one unit of a set number of equal portions of the company. Companies sell 'Shares' of stock to raise money for various types of business development.
How can I deposit a stock certificate with an online broker?
This is a rare but difficult situation but we have made a small page describing the process and who to go to! Check it out here.
What is a 'Stock Broker'?
-A Broker is essentially a middle-man that acts between buyers and sellers of 'securities'. The stock broker acts to initiate and complete the transaction between individual buyers, institutions, and 'Market Makers'. To act as a broker for securities such as stock, a license is required. Check out the next page to find out how to get your own broker.
What is a 'Market Maker'?
-A 'Market Maker', or MM for short, is a brokerage or bank that is supposed to create an orderly market for a stock. Market makers create a market by maintaining a 'bid' and 'ask' price on each stock they are participating in. The market maker should readily buy or sell the stock when their quoted prices have been met by another party. This is, of course, as long as bid or ask size is sufficient to cover the order. Market makers are critical to creating 'liquidity' and efficient trading for each security they participate.
What is a Stock Quote?
-A stock quote is a listing of prices for a stock for a specific time. A basic quote will typically include the current bid price, ask price, and the price of the last trade, sometimes referred to as the 'mark'.
Quotes can be 'real-time', or 'delayed'. Real-time is self explanatory, and delayed means the quote is simply delayed, typically 15 or 20 minutes. Quotes can also be 'streaming' or 'static'. Static quotes require the user to manually update them by clicking a link or button, whereas streaming quotes automatically update when a change to the quote occurs.
What are 'Level 1 Quotes'?
-A Level 1 Quote is simply a display of the best bid, and the best ask for a stock at the time of the quote. Unlike Level 2 quotes which are explained below, Level 1 does not show all of the market makers and their best bids and asks. Think of it as a more of a 'two-dimensional' view of a stock.
What are 'Level 2 Quotes'?
-To see the bid and ask prices that market makers are providing for a specific stock, you need a Level 2 (Level II, L2) quote. Level 2 quotes show each market maker participating in a stock, their current highest bid and lowest ask, and the 'size' of their bid/ask. Think of it as a more complete, 'three-dimensional' view of a stock. Before FINRA Rule 6460, which went effective 5/9/11, the bid/ask sizes were very rarely accurate for penny stocks. Depending on the stock price they would normally only show the minimum quote tier size depending on the price. 5000, 1000, 500, 100, etc. If the bid or ask is showing 5000 for example, the actual size could be 5000, 73,129 or 80,000,000.
What is FINRA Rule 6460?
Now with FINRA Rule 6460, market makers are required to show the size of actual customer limit orders, should the order be the current best bid or ask for that particular market maker. No longer will you only see 5000 size quotes on the Level 2. This is a good move, overall, in our opinion, and is a definite step toward more transparency in quotation. It makes having Level 2 Quotes for Penny Stocks even more valuable than before.
'Whales' with huge sell orders can no longer hide their intentions on the best ask. Manipulators will no longer be able to fake support and buying pressure by putting in multiple 5000 size orders via multiple market makers. Instead traders will be able to see real support where it actually occurs. We are not totally sure how this change is going to affect the way penny stocks trade overall, but we are optimistic that it will make things better for the retail trader.
The change doesn't make things perfect, however. There could still be orders in for less than 5000 (or whatever the minimum tier size is), or "All or None" orders placed that won't even show on the Level 2 quote. Also, one very common misunderstanding with Level 2 quotes is that the bid/asks that are showing are representing the only orders there are. This absolutely isn't true. Remember, the only ones showing are the highest bid, and lowest ask for each market maker. For example, if NITE (a very common MM on penny stocks) is showing an ask of .10, they could also have customer limit orders to execute at .11, .12, .125, and down the line.
You will often see novice traders posting on message boards and chat rooms something like, "only 6 MMs to .20!" when the current price is .10. The number of market makers to a certain price doesn't really matter, especially if the stock typically only has a few active MMs. It is the number of orders in for execution that counts, and those cannot be seen with Level 2 quotes. In addition, not everyone puts an order in and lets it sit there. There could be people waiting to 'pounce' on either the buy or sell side, which can make the Level 2 picture even more deceiving.
Understanding and interpreting Level 2 quotes is critical to improving your penny stock trading performance. Check out the links below for more information.
- Introduction to Level 2 quotes
- Level 2 quote service providers:
EquityFeed - Real time "MegaTool" geared for penny stocks
InvestorsHub - Nice service, nice price
AlphaTrade - Capable streaming Level 2 platform
Bloomfield Investment Club - Affordable streaming Level 2 quotes
QuoteTracker - Streaming real time Level 2, news, charts
QuoteStream - Streaming real time Level 2, news, charts
What is the legal definition of a 'Pattern Day Trader' or 'PDT'?
-An individual is categorized by the SEC as a 'Pattern Day Trader' or PDT when they buy and sell one or more securities (a stock for example) in the same trading day at least four times in a five day period. The individual's same-day trades must also make up at least 6% of their activity during that five day period. For most people that day trade, their activity doing so will far surpass 6% of their total activity. However, if one makes a lot of trades, but holds the most of the positions for more than the day it is possible for your day trade activity to be 6% or less. Pattern day traders are subject to special rules.
What are the Pattern Day Trader rules?
A pattern day trader must maintain an brokerage account balance of $25,000. This includes both cash and marginable securities. Technically this requirement is only necessary when the PDT is using a margin enabled account, but in practice most brokers require the $25K balance for margin and cash accounts. If you do not have, or do not maintain the minimum balance and engage in PDT activity your account will be frozen (you will not be able to buy securities) for 90 days, or until your balance is back above the $25K threshold.
What is 'Margin'?
Margin, when referring to a stock brokerage account, is essentially borrowed money that is used to buy a security. Think of margin as a type of loan, or credit line that the broker provides to its clients. Traders can use margin to increase their "buying power", the money available to buy securities/stock. Trading with margin can be very risky, since you can lose more money than you put into your account. Using margin to avoid fund settlement restrictions can be helpful, though. Just remember how much real equity you hold in your account to avoid over-extending your account with margin, and also remember the Pattern Day Trader rules (see above) to avoid any account restrictions. We recommend that new penny stock traders stick with a cash account to start.
What's Next?
-If you wanted a fuller education on the stock market, going through some entry level finance classes in online colleges is a good idea. Now that you know some stock market investing basics, and what you need to start trading penny stocks, let's discover how to buy penny stock and select a stock broker that fits your needs.
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