The Australian Stock Market, like any other world market, lists the stocks of the largest and most successful public companies such as National Australia Bank (NAB), Rio Tinto (RIO) and BHP Billiton (BHP). There are people who make thousands or even millions of dollars trading these stocks, but you would need quite a large sum of money to get started. Many people hold these stocks to receive dividends, while managed fund companies trade them with very large amounts of money.
The Numbers Tell the Story
(This example is a generalisation so you get the gist of what I mean)
To buy 1,000 shares of BHP at around $25 per share, I would need to put up $25,000. I don't have that kind of money for a single stock. If you look at any BHP chart you'll notice it doesn't usually rise or drop by much each day — it might open at $25.00 and close at $25.50. So let's say it rises 50c. That $25,000 is now worth $25,500 — up $500.
Now let's look at a penny stock sitting at $0.05. It's not unusual for one to rise $0.01 in a day, closing at $0.06. If I put that same $25,000 into this stock I'd get 500,000 shares, and my portfolio would be worth $30,000 — up $5,000.
If you have that kind of money then trade as much as you like, but many people starting out don't. From my own past trades I used to put in between $800 and $1,200 per trade, which was a good starting point. It's enough to get a worthwhile return rather than just trading $500.
To put it in perspective — if I used my usual $1,200 to buy BHP at $25.00 I'd get around 48 shares. They go up 50c and my $1,200 is now $1,224. That doesn't even cover the $30 brokerage to get in and out of the trade. Not worth it for me.
Why I Can't Compete with the Big Players
I simply can't compete with large institutions that are supplied with millions or billions of dollars in trading capital. When you're dealing at that level, a 23c move on a Blue-Chip stock makes thousands or millions. It's just not possible for the average person to compete against them in the short term.
Long term — over months or years — if you buy the right stocks in the right industry you'll most likely make money, but it's very difficult to beat the average market return consistently.
That's why penny stocks make sense for me.