How liquid a penny stock is will determine its price and more importantly, the price you will be able to buy and sell it at.

Before you start trading penny stocks, you will need to have a good understanding about penny stock liquidity and then you will need to go out and find penny stocks that have adequate liquidity. After all and once you start screening penny stocks for liquidity, you will find that some penny stocks may have no shares or only a few hundred shares traded on a given day while other penny stocks may have hundreds of thousands or even millions of shares traded each and every day.

What is Liquidity?

Liquidity is simply the ability of any given asset to be sold without causing a big price movement or a big loss in value. With penny stocks or any stock or asset for that matter, liquidity can also be a major determiner of prices or fair market values.

Hence and if you have found a penny stock with good technical indicators, checking the stocks liquidity at a given bid price will help you make a final investment decision. Specifically and if the stock has no trading volume at a given bid price, it will have low or no liquidity at that price (and for that matter, its unlikely to have better liquidity at a higher price as well).

Penny stocks with low liquidity will also have the following problems or could give you the following problems:

• There may be a good chance that if you buy the stock, you will not be able to sell it at the price you want to sell it at. In fact, you may be forced to sell it at a much lower price.
• Likewise, it will be difficult to make a large investment in a stock with low liquidity with out pumping up its price.
• Stocks with low liquidity can experience extreme volatility.
• Stocks with low liquidity can more easily be manipulated by insiders or traders. This can be done through the purchase of a large amount of stock, hyping it up in penny stock newsletters or on bulletin boards and then selling it. Such a scheme is known as pump and dump.

How to Calculate a Penny Stocks Liquidity and Limit Risk

The easiest way to determine how liquid a penny stock is would be to simply multiply the number of shares traded or the trading volume for the day by the share price. This calculation will give you an idea of how much money is flowing through the stock on a given day at a given price and help you determine whether the stock will have enough liquidity for a fair and average price.

Moreover and should you decide to purchase a stock with low liquidity or where liquidity could be an issue, use buy limit orders to set an overhead ceiling on the maximum share price you are willing to pay. And while buy limit orders on illiquid stocks can take much longer to fill, the cost savings will be worth it. Likewise, you can use sell limit orders to avoid dumping a large number of shares onto the market that could depress market prices when it comes time to sell.

The Bottom Line About Penny Stock Liquidity

At the end of the day, its important to remember that there are plenty of liquid stocks in the penny stock universe and hence, investors should have no problem finding one with both excellent technical qualities and sufficient liquidity to ensure a profit should the stock rise in value.

John Udovich is a paid contributor of the SmallCap Network. John Udovich’s personal holdings should be disclosed above. You can also view SmallCap Network’s complete disclaimer and disclosure.