Penny stocks: Too fast, too furious

If you think high volume means there's hidden value in low-flying stocks, think again.

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By Katie Benner, writer-reporter

c2.mkw.gif
How adequate is your health care coverage?
  • My employer's plan meets my needs
  • I have insurance, but it's not adequate
  • I don't have coverage
Money Summit 2009
Ali Velshi & the CNN Money Team take on the dismal February jobs report. How will the job market recover?
Watch a special AC360
Friday at 11 p.m. ET

NEW YORK (Fortune) -- Even though Citigroup shares dropped below a dollar Thursday, volume appeared healthy as 577 million shares changed hands.

Other blue chips like Hewlett Packard (HPQ, Fortune 500) and Johnson & Johnson (JNJ, Fortune 500) traded between 20 million and 30 million shares, while the average trading volume per Dow component hit 250 million.

Citi (C, Fortune 500) wasn't the only blue-chip-turned-penny-stock that traded at outsized volumes - 283 million shares of Bank of America (BAC, Fortune 500) traded hands, closing near $3; and volume for AIG (AIG, Fortune 500), which closed at 35 cents, hit 62 million.

But before you think that active trading in stocks trading so low means there's value there, think again. The flurry of activity is more likely the thrashings of a badly wounded company than the stirring of a firm rising from the dead.

"For the most part, what you're seeing is active traders making a few bucks in these names," says Michael Lewitt, president of Harch Capital Management. "It's sort of like gambling or playing craps."

Lewitt and other money managers describe this is an "option value situation," meaning that traders don't need to put a lot of capital at risk to make a return. If AIG goes to 50 cents from 35 cents and you can get your money off the table, you've made a 43% gain and risked very little capital.

Markets have always attracted investors who trade penny stocks to make quick money on their volatility. But now they're sweeping into shares that traditional buy-and-hold investors dominated for decades, a change that shows just how much this market has shifted radically in a short period of time.

"The volume reflects that people are piling in to buy for the trade, knowing that those stocks are highly volatile," says Lewitt. "But these companies have negative net works and their capital base, even at Bank of America, has been or will be wiped out. Few people believe they're turnarounds. They're treating them like companies that will need to be restructured."

Active traders in AIG, Bank of America, and Citi are betting that further government intervention (or even just news thereof), is a factor that could give these stocks a short pop, says Barry Ritholtz, the director of equity research at Fusion IQ, an independent quantitative research firm.

"AIG has gone up 300% at times on a politically-driven bounce," says Ritholtz. "All you need is for someone to come on TV and say that a government is about to intervene, and the stock will move."

Ritholtz says institutional money is another contributor to active trading in these names. There is still massive institutional ownership for these names, and they can only sell so much at a time.

"If you're a big owner, you can't just dump millions of shares because you can't find the buyer for that much," he says. "So you could also be seeing a steady stream of selling."

It's a bad situation for institutional money, and only good for the few day traders who manage to get the timing right on these names. In short - it's just the kind of situation the average investor wants to avoid. To top of page

Company Price Change % Change
Bank of America Corp... 16.15 0.00 0.00%
Facebook Inc 58.94 0.00 0.00%
General Electric Co 26.56 0.00 0.00%
Cisco Systems Inc 23.19 -0.02 -0.09%
Micron Technology In... 23.91 0.00 0.00%
Data as of Apr 17
Index Last Change % Change
Dow 16,408.54 -16.31 -0.10%
Nasdaq 4,095.52 9.29 0.23%
S&P 500 1,864.85 2.54 0.14%
Treasuries 2.72 0.08 3.19%
Data as of 2:47pm ET
More Galleries
50 years of the Ford Mustang Take a drive down memory lane with our favorite photos of the car through the years. More
Cool cars from the New York Auto Show These are some of the most interesting new models and concept vehicles from the Big Apple's car show. More
8 CEOs who took a pay cut in 2013 Median CEO pay inched up 9% in 2013 to $13.9 million. But not everyone got a bump last year. Here are eight CEOs who missed out. More
Sponsors
Worry about the hackers you don't know 
Crime syndicates and government organizations pose a much greater cyber threat than renegade hacker groups like Anonymous. Play
GE CEO: Bringing jobs back to the U.S. 
Jeff Immelt says the U.S. is a cost competitive market for advanced manufacturing and that GE is bringing jobs back from Mexico. Play
Hamster wheel and wedgie-powered transit 
Red Bull Creation challenges hackers and engineers to invent new modes of transportation. Play

Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.