And, for the first time ever, the Shanghai Stock Exchange (an emerging market) acted as a catalyst for a sell off on established exchanges (mature markets) around the world.

The dust has settled and the markets are still looking for some decent footing. Was the North American sell-off justified? And do penny stock investors need to brace themselves for a bumpy ride?

First off, the Dow Jones Industrial average hadn’t experienced a 2% correction in well over 100 days. So really, it could be argued, it was just a matter of time. Unfortunately, the sell-off was precipitated by the Shanghai meltdown. And under no circumstances should well established North American exchanges be influenced by emerging markets.

While ignorance may be bliss, in this case, it wasn’t. Yes it’s important to investigate a penny stock you want to invest in...it's also a good idea to investigate the exchange as well.

The Shanghai Stock Exchange is what we refer to as an emerging market. An emerging market is a financial market in a developing country that usually has a small market with a short operating history.

The Shanghai Stock Exchange was created by the Chinese government in the 1990s and has a market capitalization of $1.15 trillion. While $1.15 trillion may sound like a lot, compared to the mature markets here in North America…it’s not.

The NYSE and Nasdaq have a combined market capitalization of $19.30 trillion, and the Toronto Stock Exchange has a market cap of $1.7 trillion.

Sure China has 1.3 billion inhabitants and their economy is on fire, but that doesn’t mean they have a stock market that’s a beacon of light. In fact, many reports note that the Chinese markets are riddled with corruption and lax government practices.

Fundamentals are largely ignored in favor of rumors and speculation. Chinese investors have been known to run up the price of a company’s stock when it reports bad news.

If China’s markets are such fickle places, why did stock exchanges from New York and Toronto get spooked? Probably because we don’t understand the scope of this emerging market.

“It’s a purely speculative market,” noted one Peking University finance professor. “It’s driven by speculation about the government’s intentions.”

This speculation helped the Chinese markets post double digit gains in 2004 and 2005. Which begs the question, if the North American markets weren’t rising on the back of the Shanghai Exchange, why should they sink with it now?

Exactly, they shouldn’t.

North American penny stock investors view the NYSE, NASDAQ and TSX as an indicator of growth and future prospects. That can be a dangerous assumption with emerging markets.

This is compounded when you consider that of the 1.3 billion people in China, the majority live in rural areas and do not own stocks. Meaning, the markets recent dip affected only those living in Shanghai and other cities. “And that’s not the real China,” said one economist.

Not that the North American markets don’t have their own economic issues to contend with. The slowing economy, weakening housing market, rising gasoline prices, and soft retail sales are all issues that, on their own, make for a volatile ride.

But a one day dive in an emerging market of a country whose economy is one-fifth the size of the U.S…should not make any penny stock investor lose sleep.

A seasoned investor with a keen interest in international business and current affairs, John Whitefoot has been working alongside Peter Leeds for the last several years. With over ten years experience in the investing community, Whitefoot is devoted to uncovering the news, trends and ideas that shape penny stocks on a daily basis.