Trading penny stocks is risky, but also highly rewarding. The biggest advantage of trading penny stocks is that it does not require a large account. As their name suggests, penny stocks are inexpensive and easily accessible to holders of small trading accounts. You don’t need to have a lot of money to plunge into penny stock trading.
Here are some more advantages:
- Getting started is as easy as eating a slice of cake. You don’t need any educational qualification or specialized tools. You just need an account at a reputed online broker and a computer with a fast and reliable Internet connection.
- The biggest disadvantage of penny stocks also happens to be their biggest advantage, and that is lack of regulation and information about penny stocks companies. But if you have the patience to do your homework, you can easily figure out if a company is worth investing in.
- Penny stocks fetch profits whenever they lose or gain. Most penny stocks ultimately fail, but they provide lucrative short selling opportunities. When you short sell, you capitalize on a stock’s falling value.
- Penny Stocks Basics
- Trade after Hours
- How Penny Stocks Turn into Regular Stocks
- Penny Stocks Are Risky
- Volatility of Penny Stocks
- 4 Points to Keep in Mind before Trading Penny Stocks
- 4 Factors that Make Penny Stocks Very Risky
- How to Choose the Right Penny Stock Broker
- Two Major Penny Stocks Scams to Beware Of
- How to Become a Successful Penny Stocks Trader?
- 10 Tips to Pick the Best Penny Stocks for Trading
- Minimizing Risks – Top Tips to Cut Your Penny Stocks Trading Losses
- Penny Stock Trading FAQs
- Conclusion – Should You Trade Penny Stocks?
Penny Stocks Basics
Penny stocks are small company stocks that trade for lesser than $5 per share. Most of them are traded over the counter (OTC), but a few of them are traded on noted stock exchanges such as the New York Stock Exchange (NYSE).
Penny stocks are traded either via the electronic OTC Bulletin Board or via private Pink Sheets. Since OTC transactions lack trading floors, the quotations are electronically done.
Creation of Penny Stocks
Penny stocks are created by start-ups and small companies that issue them in order to raise the funds required to start and develop their business. The procedure is among the most efficient and fastest ways for start-ups to obtain the required capital. Penny stocks are issued through initial public offering (IPO).
The OTC Bulletin Board will list a company only if it either registers with the US Securities and Exchange Commission (SEC) or issues a statement that it qualifies to be exempted from registration. After getting the required approval, the company can start selling its shares to investors. Later, the company can get listed on a bigger stock exchange or trade via OTC.
SEC’s Rules for Penny Stocks
The Financial Industry Regulatory Authority (FINRA) and the SEC have issued a set of rules to protect those who trade penny stocks. These rules govern the sale and purchase of penny stocks and are as follows:
- All penny stock brokers have to comply with Section 15(h) of the Securities Exchange Act of 1934 to become eligible to handle penny stocks transactions.
- The broker has to approve the transaction and ensure that it is suitable for purchase.
- Brokers have to give their customers a document containing details of all the risks associated with purchasing penny stocks, ways to deal with fraud, and information related to customer rights.
- Brokers have to disclose and confirm the latest price quotation before completing the transaction.
- Brokers have to send account statements with details of each penny stock purchased by their customers every month. Each statement should clearly indicate that penny stocks have limited market liquidity and give an estimate of the share value.
Trade after Hours
You can trade penny stocks after market hours. Since the markets move and develop in significant ways after the stock exchanges close, penny stocks can become very volatile after hours. If you buy or sell after hours, you may be able to either buy at incredibly low prices or sell at very high rates.
On the downside, penny stocks are not liquid. Even if their volatility increases after market hours, you won’t find it easy to sell your stock. The trade volume of penny stocks is very low and dips lower after market hours, making it very difficult for traders to make purchases and sales.
How Penny Stocks Turn into Regular Stocks
A number of factors are responsible for the turning of penny stocks into regular stocks. Companies can either issue new securities in SEC registered offerings or register existing securities with the SEC. If they do so, they will have to provide regular reports of their management, financial conditions, and activities to investors.
Companies also have to report to the SEC under certain circumstances. For example, they have to submit reports if they either have 500+ investors who cannot be considered accredited or a minimum of 2000 investors. Although it is not mandatory for companies that have lesser than 2000 shareholders and assets that do not exceed $10 million in value to file reports with the SEC, some of them still do so because they value transparency.
Businesses that list their securities on national exchanges such as NASDAQ and NYSE ought to file reports as well. If the securities of a company are quoted on OTCBB or the OTC Link’s OTCQB marketplace, it has to register with the SEC.
Penny Stocks Are Risky
Although penny stocks were previously considered to be all stocks trading for less than $1 per share, the SEC now defines them as all stocks that trade below $5 per share.
Since penny stocks comprise small company shares with low trade volume, they don’t have adequate liquidity. As a penny stock trader, you may find it difficult to sell the stock you hold. Owing to their low liquidity, wide price quotes, and the small size of the companies that issue them, penny stocks are considered to be highly speculative. As an investor, you could lose a considerable portion of your investment or even all of it.
Volatility of Penny Stocks
Since penny stocks are small companies or start-ups that lack adequate financial resources, they are suitable for traders capable of handling high risks. Penny stocks are highly volatile, which indicates that they can yield larger rewards. At the same time, they are also associated with high risk.
If they are not careful to enter and exit at the right time, investors can lose all the money they invested. And if you buy on margin, you may lose more than your investment amount.
4 Points to Keep in Mind before Trading Penny Stocks
If you are ready to start trading penny stocks, you have to keep the following points in mind. Get started only with money you can afford to lose and do your research well. You will soon learn that investing in penny stocks is not only easy, but also fun. You will be all the more delighted when you convert a few dollars of investment into a large profit.
The following are four points to keep in mind before trading penny stocks:
#1: Paper Trading – Best Way to Start Trading Penny Stocks
If you are looking for a get-rich-quick scheme, penny trading is not your cup of tea. If you enter the penny stocks market with such an attitude, you are heading towards disaster. Avoid plunging headlong into penny stocks trading with a wad of cash in your hands. On the contrary, the best way to get started with penny stocks trading is with zero money and zero risks.
Get started with paper trading, a great way to find out how much you could have gained or lost had you been trading for real. Paper trading does not require any expensive software programmes, apps, or trading tools. All you need is paper and a pencil.
#2: Invest Money You Can Afford to Lose
Trade penny stocks only with money you can afford to lose. Many new traders make the mistake of using funds set aside for important things such as groceries or rent with the hopes of making a quick buck. It is not going to work out that way.
If you use money that you just cannot afford to lose, you are going to experience a lot of stress, impatience, and frustration. You will also be obsessed with the idea of making a profit. You will then make crucial decisions emotionally, only to get the wrong results.
On the other hand, if you are trading with money you can afford to lose, you will be emotionally detached and calm. In this state of mind, you can make a better market decision, and this will put you in a better position to make profits.
#3: Register with a Discount Broker
Discount brokers execute trade orders at lower rates of commission, but do not provide market analysis, technical analysis, and investment advice the way full-service brokers do. Despite this disadvantage, discount brokers are popular among new traders because they allow them to get started on a small capital and at nominal fees.
To start trading penny stocks, you have to open an account at a discount broker. It takes anywhere between a few seconds to a few hours to a few days depending on the online broker’s policy. You may also have to deposit a minimum account although some discount brokers allow you to get started without having to make any minimum deposit.
Once you make your deposit, you can use it to purchase and sell shares.
#4: Learn to Pick the Best Penny Stocks
The secret to success in trading penny stocks is learning how to pick the best of them. You have to learn to identify the very shares that are capable of moving in the direction you predict. You cannot just copy someone else’s choice as it may not work for you. This is because everybody picks stocks as per their individual goals, capital, and trading styles.
4 Factors that Make Penny Stocks Very Risky
While trading penny stocks, you are exposing your capital to a variety of risks. The SEC advises investors to watch out for spam, trading suspensions from the SEC, companies having huge assets and small revenues, unusual auditing issues, and strange items in the footnotes of financial statements of companies issuing penny stocks.
Here are 4 factors that make penny stocks extremely risky.
#1: Lack of Information
Traders need to get as much information as possible to make an informed trading decision. When you are trading penny stocks, it is very difficult to get the required information. This is because penny stocks are issued by new companies and start-ups, not reputed and well-established companies listed on major exchanges. Also, you cannot trust the source of the limited information you do receive.
OTCBB traded stocks bear the suffix “OB,” and companies issuing them submit financial reports to the SEC. But pink sheet companies do not have to submit any reports to the SEC. These businesses, therefore, are not regulated and followed as much as those listed on the NASDAQ, NYSE, and other exchanges.
#2: Penny Stocks Need Not Maintain Minimum Standards
Companies listed on pink sheets and the OTCBB are not required by the law to maintain the standards that companies listed on bigger exchanges are required to maintain. When a company is unable to maintain the standards required to continue being listed on a major exchange, it is removed from the listing. It then moves to an OTC exchange.
#3: Penny Stocks Lack History
Since penny stocks companies are brand new, not much is known about them. Some of them could be on the verge of declaring bankruptcy. When you cannot get information about the history of a company, you will be unable to determine the actual worth of its shares.
#4: Lack of Liquidity Leads to Fraud
Since penny stocks do not have a high trade volume, they lack adequate liquidity. This makes it very difficult for traders to sell the stock they are holding. They may also be forced to sell the stock at lower rates. The low liquidity of penny stocks gives some unscrupulous traders the opportunity to manipulate the prices of stocks to their advantage.
How to Choose the Right Penny Stock Broker
Now that you are aware of the basics of trading penny stocks and the risks associated with it, you can get started. The first step is to choose the right penny stock broker. If you want to become a successful penny stocks trader, you have to choose the correct broker.
You won’t find an online broker specializing in penny stocks, but you will find several brokers that give you the opportunity to trade penny stocks. They have their own pricing policies, as a result of which, they offer different rates of commission.
However, be careful about trusting brokers that offer their services for either no commission or a very low rate of commission. They may be doing so because they have terrible customer support, low-quality trading tools, or are unable to execute trade orders fast. The best brokers in the industry may charge higher rates of commission, but they also execute trade orders fast and offer excellent trading tools and 24/7 customer support.
Before opening an account, you should not only study the pricing policy, but also find out whether the broker charges fees for trading OTC stocks or penny stocks trading for lesser than $1 per share.
Two Major Penny Stocks Scams to Beware Of
Since penny stocks, especially those trading for lesser than $1 per share, have very low liquidity, unscrupulous traders can easily manipulate their prices to cheat other investors and make a profit.
Pump and Dump Scam
The most common penny stocks scam is called “pump and dump.” It has been around for a long time and the Internet has made it easier than ever for fraudsters to execute it.
The stock is first “pumped.” In other words, the trickster or the group of tricksters choose a company to pump and buy up hundreds, thousands, or even millions of its shares. They then spread word on how it is the best stock to invest in at present. They may even issue press releases, open websites, or send emails to unsuspecting investors for this purpose.
As a result, investors get interested in the stock and start investing in its. This increases the trading volume of the stock, as a result of which its price shoots up. The tricksters now “dump” the stock, or in other words, they sell the stock and make a huge profit. The price of the stock immediately falls and the tricksters vacate the scene, leaving hundreds and thousands of investors holding stock that has now become worthless.
Penny Stock Promoters
You have to also beware of penny stock promoters, which exist in the form of websites offering free newsletters with the hottest picks or lists of the best stock to invest in. These are paid by companies that want to promote their shares. The companies may also call these activities as “investor awareness campaigns.”
Companies hire promoters to create advertisements that generate awareness of their stocks and to attract traders. They do this because they want more investors so that they can obtain the funds required to develop their business. In some cases, shareholders of the company may want to sell their shares at higher prices.
When you look at it closely, stock promoters are using the “pump and dump” technique, but it still cannot be called a scam if they let investors know that they are promoting the stock because they have been paid to do so.
As a result of stock promoters’ activities, the price of the shares increases in just a few weeks. When the promoting stops, the price of the shares also falls. Smart investors can make a quick profit from these stocks if they know exactly when to enter and when to exit. But a number of new investors end up losing their funds because they make the mistake of investing long-term in the stock.
How to Become a Successful Penny Stocks Trader?
To become a successful penny stocks trader, you should learn how to avoid these scams, and here are a few tips to help you do so:
Investigate All Stock Recommendations Carefully: If you come across anybody promoting a penny stocks list, investigate them thoroughly. Try to find out about their source of information. They may be getting tips from the company they are promoting or from paid promoters trying to make a profit out of gullible investors.
Research the Companies: Research the companies thoroughly before you purchase their shares. Visit their websites, read their financial reports, and any other information you can get your hands on. It is very difficult to obtain valid information about these companies, but investigation will reveal a lot of things about them.
Pick Companies Listed on Major Stock Exchanges: Ideally, you should stick to companies that are listed on major stock exchanges. Expert traders also pick companies at OTC exchanges and pink sheets, but they are associated with huge risks. These are the penny stocks that are most exposed to price manipulation.
Verify Stock Promoters’ Claims: Stock promoters often make tall claims simply because they are paid to do so. The intention is to get you interested in the stocks and make you buy them. Never believe these claims until and unless you have thoroughly verified them.
Practice Scepticism: Just don’t take anybody’s word for anything, even if they happen to be trading gurus who have turned over huge profits. Do your homework always, stay alert, and verify facts before you make a trading move.
10 Tips to Pick the Best Penny Stocks for Trading
Now that you have selected a reputed online broker and armed yourself against penny stocks scams, it is time to start picking the best penny stocks for trading. Picking stocks is an art that you have to master on your own. Each trader has his/her own way of picking stocks based on his/her trading goals, strategies, personality, and trading style.
Here are 10 tips to help you pick the best penny stocks for trading:
- Stay Informed: Before picking a penny stock, spend several hours or even days or months researching it. A simple Google search will not give all the information, but it can definitely help you decide whether it is worth considering the stock. For instant, if a simple Google search reveals just a badly designed website or a Facebook page with scanty details, you may decide not to have anything to do with the stock.
- Volatility: Volatility is an important factor to consider while picking penny stocks. You want to avoid stocks that move too slowly as only fast-moving stocks can give you any profit. You need to pick the ones that move the fastest. A good stock screener tool can help you filter lists of fast moving penny stocks.
If your stock does not move or moves too slowly, you will have a hard time buying or selling it. You may even find it difficult to sell the stock you hold.
- Trade Volume: Similarly, you need to pick stocks with a high trading volume. A company’s press release or financial reports may look attractive, but you should avoid it if it does not have a high trade volume.
Volume refers to the number of shares traded in the course of one day. Ideally, you should choose stocks that trade at least one million shares per day. Most traders pick only those stocks that trade several millions of shares per day.
High volume indicates that traders are interested in the stock. It also means that you won’t struggle to find a buyer for your stock when it is time to sell it. You can even grab a larger position if you want one.
- Stay Alert for Catalysts: Catalysts are events that can result in rapid price movements within the market. If, for example, a particular company announces the release of a new product, you can expect the price of its shares to rise irrespective of whether the product sells or not.
News of personnel changes, sales, mergers, scandals, and so on could also serve as catalysts to price movements in the market. If you pick a stock, stay alert for any catalyst that could have an impact on that stock.
- Listen to Other Traders: You don’t have to take their advice, but it always helps to know what others are thinking about particular stocks. Discuss penny stocks in public forums and on social networking sites to get a better idea on how to pick your own stocks.
But do not follow anybody’s advice blindly. Also avoid copying someone else’s list of top penny stocks for trading as what works for others need not necessarily work for you.
Observe other traders’ activities, listen to what they say, study their trades, but think for yourself, develop your own strategy, and pick your own penny stocks.
- Learn about Patterns: You can learn a lot from similar patterns in the markets. Base your choice of stocks and trading strategies on key patterns. They may not always be exactly alike, but they can definitely help you to predict the future.
Learn to identify patterns so that you can easily make predictions and be prepared for them. There are plenty of lucrative opportunities hidden in patterns.
- Check the Time: What’s your daily schedule? When do you usually login to your online brokerage account? The best penny stocks to trade in the morning need not necessarily be the best stocks to trade in the afternoon. Some stocks are great for trading during the early hours or even the aftermarket hours, but not at any other time of the day.
- Find out about Company Debts: You should always research the financial well-being of a company before trading its shares. Rely on both fundamental and technical analysis to help you with this. Take the time to read the earnings report and find out whether everything is well with the company. Companies in debt are usually not on the road to success. This doesn’t mean you should avoid the stock, but you would like to use a different trading strategy for it.
- Liquidity: All companies have their own liabilities and assets. You can determine the company’s liquidity ratio by making a comparative study of the two. If the company’s assets are more than its liabilities, it has a good liquidity ratio. You don’t have to worry about trading the stock as the company has enough money to grow and develop and become a success.
- Use Stock Screeners: Choosing from hundreds and thousands of penny stocks is a daunting task, but a good stock screener can make things very easy for you. Use the stock screener to filter penny stocks on the basis of criteria such as market capitalization, volume, volatility, and so on. You will find plenty of free stock screener tools online and you just have to choose one of them to get started.
Minimizing Risks – Top Tips to Cut Your Penny Stocks Trading Losses
While you can make a lot of money trading penny stocks, you can also lose a lot of money. However, you can learn how to manage the risks, cut down your losses, and protect your profits. After all, a number of traders do make money trading penny stocks.
- Pick the Right Penny Stocks: Stick to the stocks you find in the OTCQX level of the OTC exchange as companies listed on it are required to maintain higher financial standards. They have to comply with SEC regulations and maintain operational standards higher than those set by the OTC Pink Markets and the OTCQB levels.
As far as possible, do not pick Pink Sheet stocks as any trickster can easily manipulate the share prices and take investors for a ride. Investing in reputed companies not only reduces risk, but also guarantees returns.
- Avoid Overtrading: After picking your penny stocks list, create a proper trading strategy and stick to it. Know exactly when to enter and exit, cut down your losses, and protect your profits. Do not get emotional if you lose and avoid chasing your losses with the hopes of making huge profits.
- Don’t Invest: Penny stocks are ideal for day trading, not long-term investment. You can make a profit if you buy and sell penny stocks on a daily basis. Do this every day and every week, and as the years roll, you will find that you are making quite a lot of money.
Penny Stock Trading FAQs
Here are a bunch of questions that new penny stocks traders ask on a regular basis:
Q1: Can I make money with penny stocks?
A: You can definitely make money trading penny stocks, but it all depends on your trading strategies and trading goals.
Trading penny stocks is not like playing lottery games, but many new traders make the mistake of thinking that luck plays a major role in making profitable trades.
The simple truth is that luck has nothing to do with penny stocks trading. You need to invest a lot of time and effort in understanding market moves, identifying patterns, and picking the right stocks if you want to see any profits.
Q2: How can I buy penny stocks?
A: You can easily purchase penny stocks thanks to the Internet. All you need to do is open an account at a reputable online broker such as Interactive Brokers, Robin Hood, Etrade, and others. Research the broker well and find out how much commission they charge and how fast they execute trades. Brokers that do not charge fees or commission for penny stocks trading are usually poor at executing trades.
Q3: Do I have to be glued to my computer all day to become a successful penny stock trader?
A: No. You just need to stay committed and spend a few hours in research and stock picking every day. Several successful traders are students who trade whenever they get some free time.
Q4: Is a broker essential for penny stocks trading?
A: Yes, you need to create an online brokerage account to start trading penny stocks. Opening an account is free and easy. We recommend getting started with a discount broker.
Q5: Can I learn penny stocks trading without risking my own money?
A: You don’t have to risk a single penny of your hard-earned cash to learn penny stocks trading. Avoid plunging headlong into real money penny stocks trading. Instead, start with paper trading and learn as you go. You can start trading with real money when you are confident about your skills and knowledge.
Q6: How much money do I need to start penny stocks trading?
A: You don’t need any money to start penny stocks trading. You don’t have to spend a dime till you have learned all the tricks of the trade. When you feel that the time is ripe to start trading penny stocks for real money, you have to choose the right broker. You have to make a minimum deposit to start trading. Some brokers don’t force you to make a deposit; instead, they encourage you to start with a demo account.
Q7: How many penny stocks should I buy at a time?
A: It depends on your skills, level of expertise, and the risk you are capable of handling. Avoid putting all your eggs in one basket. Instead of investing everything on one stock, spread your capital across multiple stocks.
A lot depends on your trading philosophy, personality, style, goals, and strategies. You can invest in just a few penny stocks or plenty of penny stocks. What works for one trader need not necessarily work for another. Find out what suits you the best.
You just have to follow the simple rules of trading with money that you can afford to lose and of not putting all your money on one stock.
Q8: How can I find out if a company is legitimate?
A: If you are trading penny stocks of companies listed on major exchanges such as CDNX, TSX, NASDAQ, AMEX, or others, you can easily check the legitimacy of the company. If you are trading penny stocks of a Pink Sheet company, you will find it very difficult to obtain valid information about that company.
This is because Pink Sheet companies don’t have to submit financial reports to the SEC. Most of these are really bad companies that won’t stay around for a long time. You can use Better Business Bureau if you wish, but this won’t be of much help because fraud companies keep changing their names to fool investors and make their profits.
Do not believe everything that you read on the company’s official website because you have no way of verifying the information they reveal. You can call the company, send them an email, and read their press releases. If they have submitted any documents to the SEC, take the time to read them as it will give you a good idea about their legitimacy.
If you want to make safer investments, pick penny stocks of companies listed on major exchanges such as the AMEX, SmallCap, NASDAQ, and others. The exchanges have already done the job of researching these companies before listing them.
Q9: What factors have an impact on the penny stocks markets?
A: Factors such as oil prices, movements in interest rates, political uncertainties, government policies, and others have a major impact on penny stocks markets.
Q10: What is halting and why does it happen?
A: Companies can voluntarily halt their penny stocks if they have news that may have a major impact on the price of shares. Or the exchange on which it is listed can halt penny stocks because the company failed to submit the required reports or meet the required standards.
You cannot trade halted penny stocks. If a company has halted the stock temporarily just to release some important news, you can start trading it again, but at a different price. Sometimes, penny stocks are halted for a few hours, days, weeks, or even months. Sometimes, penny stocks are halted permanently.
Conclusion – Should You Trade Penny Stocks?
Penny stock trading is not everybody’s cup of tea. In fact, some traders just don’t understand them. Most traders steer clear of them as a majority of the companies listed on OTC exchanges are just bad companies that are floundering in terrible financial conditions.
But there are a number of traders who know exactly how to profit from penny stocks. Most of them trade only those stocks that trade at least $3 per share. They never listen to penny stocks promoters and never copy the penny stocks lists of trading gurus. They avoid Pink Sheet companies and don’t subscribe to newsletters that clutter their inbox with free stock picks, top penny stocks of the day, and other listings.
In other words, successful penny stocks traders trust their own knowledge, experience, strategy, and expertise. They know exactly how to pick the most rewarding stocks and trade them in the most profitable manner.
If you have the patience to spend several days, weeks, or maybe months in just learning about trading penny stocks, you have a chance of becoming successful. Do not get obsessed with profits. Start with paper trading and demo accounts. When it is time to invest real money on the penny stocks, you will be rewarded for your patience and the hours you spent in research and study.