The '$5 Threshold' Trading Strategy Explained

Stocks that trade below $5 are considered by Wall Street to be "penny stocks." These oft-derided, decidedly risky equities are populated by both illiquid, unlisted, wildly speculative "lottery ticket" companies that trade over-the-counter, and reputable companies that are either just beginning to grow or have perhaps fallen on hard times.

Stocks that trade below $5 are considered so risky that institutional investors, including pensions and mutual funds, aren't allowed to buy penny stocks and can even be required to sell securities that fall below the $5 mark. This double-edged sword cuts both ways, however, when an issue rises above $5 and institutions are allowed to buy.

This forms the basis of the $5 threshold trading strategy.

When stocks cross the $5 barrier in a bearish manner and institutions sell, the market is flooded with shares and the price is driven down. When a stock rises over that $5 threshold, institutions and hedge funds can, and sometimes do, load up on shares which in turn drives the price higher.

Two such penny stocks with the $5 threshold approaching are Federal National Mortgage Association FNMA and Federal Home Loan Mortgage Corporation FMCC. These government sponsored enterprises (GSE) have received a spike in interest as president-elect Donald Trump's administration is expected to explore privatizing them and an ongoing court case will decide the fate of the GSE's profits.

Fannie Mae and Freddie Mac traded at $4.35 and $4.27 in Thursday's session.

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