Penny stocks are stocks owned by small companies that usually trade for less than $5 per share. They are also known as nano-cap stocks or small-cap stocks. The term “penny stocks” was initially used to describe stocks that traded for less than a dollar, but has evolved (mostly due to inflation) to describe all stocks with a share price of less than $5.
Penny stocks rarely get listed on major public exchanges. Instead, these types of stocks are primarily traded on the Over the Counter Bulletin Board (OTCBB) and are often known as OTC stocks.
The Securities and Exchange Commission (SEC) is the government agency that regulates stock trading in the United States. According to SEC stock rules, a penny stock possesses the following features:
- A penny stock is a small company stock and is worth less than $5. These companies usually have a market capitalization of less than $300 million. A private company with no active trading market can also trade in penny stocks.
- Sometimes, penny stocks trade on a major stock exchange like the NYSE or NASDAQ, but they usually trade on the OTC Link LLC or the OTC Bulletin Board (pink sheets).
- A penny stock is very volatile and illiquid. It can be challenging to sell it when you want to.
- It can be difficult to find quotations for penny stocks, hence the difficulty in getting accurate stock prices.
Investing in Penny Stocks
Investing in stocks is a potentially rewarding undertaking, but not without its risks. Like a regular stock investment, trading penny stocks requires a bit of strategy, know-how, and good fortune. If you are considering trading penny stocks, you will be shrewd to acquaint yourself with the potential highs and lows associated with dealing in these securities.
A penny stocks list is essentially the same as a regular stocks list. The only difference is that penny stocks are priced very low. Certain qualities of penny stocks make them high risk, so you would do well to consider their qualities before committing your capital.
Qualities to Consider
- Little historical data: Penny stock companies are relatively new and usually do not possess enough performance data. Inadequate data makes stock analysis difficult.
- High volatility: Penny stocks are very responsive to the news cycle. Investors will usually buy penny stocks in anticipation of a product release that could lead to a jump in the share price.
- Low liquidity: Illiquidity means you are unable to get cash for your stocks when you want it. The absence of cash can significantly affect trading volumes, causing relatively small transactions to cause marked shifts in stock prices.
- Little public information: Penny stock companies do not have to file regular regulatory reports with the SEC. Their stocks are also rarely followed by professional analysts, so there are fewer ratios and stock reports. Potential penny stock traders will also have to contend with the problem of stock information from less than credible sources.
- Susceptible to manipulation: Insufficient information makes penny stocks an easy target for scammers and stock manipulators. Unethical traders can cause artificial inflation of stock prices they have acquired through media platforms and leave unsuspecting buyers with significant losses when share prices become stable.
Should I Invest in Penny Stocks?
Penny stocks are very speculative high-risk investments. This means that there’s a huge chance you could lose a large part or even all of your capital. On the flip side, it also means that they offer potentially high profits. There is a real possibility that you could hit the big-time from almost nothing by trading penny stocks. Thus, you should consider penny stocks if you do not have a large bankroll but want to go into active trading.
If you have decided to go into penny stock trading, the first thing you’ll want to do is get a reliable broker. Brokers are professionals who serve as intermediaries between you and other stock traders. Some are freelancers, while others work as employees of trading companies. Brokers provide the required platform and infrastructure for trading. Their activities can also influence trading patterns and strategies of traders on the stock market.
Getting a Penny Stockbroker
Choosing the right broker for you is a crucial decision if you want to succeed as a penny stock trader. The kind of stockbroker you’ll want depends on your short and long-term goals. In the past, stockbrokers offered full brokerage services. Investors would call them over the phone to buy or sell a stock for a relatively significant fee. They also provided other services like consulting on stock buying and tax filing.
The Internet has changed the way most stockbrokers work. Today, investors can carry out transactions over the Internet in record time and for smaller fees. The Internet’s ubiquity and ease of use have also led to the proliferation of online brokerage firms.
The sheer number of online brokerage firms can leave a rookie investor overwhelmed. If you are undecided about which broker to choose, let’s look at some factors to consider before making a choice.
Factors to Consider When Choosing a Stockbroker
- Fee structure: Some stockbrokers charge you per share, while others charge a fixed rate no matter how many shares you buy. You might want to consider a broker who charges a fixed fee if you’re going to trade penny stocks. Other brokers will also penalize you if your account balance runs below a specific figure or is inactive for a while. You will want to consider whether you are willing to pay such punitive fees.
- Ease of use of website and apps: You want to choose an online platform that is easily navigable. A complicated platform can make trading a tedious affair.
- Diversity of trading markets: You should consider a broker that gives you diverse trading options. It will be easier to spread your portfolio if your broker can trade in many markets.
- Trading research tools: Online brokers have research tools like stock screeners and charting software that will make your trading journey a lot easier. You should consider the availability of these tools carefully before deciding on a broker.
- Quick trade times: Speed is an essential requirement in penny stock trading. Penny stocks are volatile, meaning prices can change quickly. A broker who executes your demand in real-time will help you take advantage of opportunities immediately. That way, you will also be better placed to mitigate or avoid potential losses.
- Customer service: You may want a platform that responds to queries and complaints promptly, either by phone or email.
Do Your Research
These factors are by no means exhaustive. The bottom line is this: whichever brokerage firm you opt for, ensure you have done your research and are positive that what it offers meets your trading needs.
Trading penny stocks is an alluring endeavor. The prospect of getting stocks on the cheap and selling for megabucks is a stock penny trader’s dream. However, you should acquaint yourself with the facts. There is a lot of pessimism regarding penny stocks. The reality is that most penny stock traders will lose some or all of their capital. There are dozens of failed penny stock investors for every successful one. Allow this knowledge to guide your decision on whether you should decide to commit your money.
Best Brokers for Penny Stock Trading
There are many firms offering brokerage services. Newbies to penny stock trading can be overwhelmed with the number of options available to them. Acquaint yourself with their advantages and disadvantages before making a choice. There is a broker for every need. Below is a list of the most notable names in penny stockbroking:
- Interactive Brokers
- Fidelity Investment
- Charles Schwab
- TD Ameritrade
- TC2000 Brokerage
- Ally Invest
A full review of these top penny stockbrokers is available here.
Penny Stock Trading Without a Broker
Registering an account with a broker is the most popular way of getting started with penny stock trading. However, many traders will decide to go it alone. Having a broker saves you time and energy for a relatively small fee. If you want to cut out the middleman, you must be able to commit the time and patience to study and absorb the complexities of the penny stock market. You should be able to obtain and understand information about the most viable penny stocks available. If you have a handle on trading jargon and can make an informed assessment of companies, then trading solo might be for you.
Ultimately, penny stock trading without a stockbroker requires rationality, patience, and a willingness to stick to your penny stocks for long periods without wavering or second-guessing your decisions.
Ways to Trade Penny Stocks
Different traders may have their strategies or thoughts on how to succeed in trading stocks. Whatever your thoughts are, there are some general guidelines you should adhere to, especially if you are a beginner.
Only Invest Funds That You Can Afford to Lose
When it comes to penny stocks, the only thing you can be sure of is that most investors will lose money. This high failure rate means that you should make room for the possibility that you will not make money—or worse. You will sleep more soundly if the only money you’ve committed is that which you can afford to let go.
Invest in Companies You Understand
It’s easy to fall for the grandiose claims of success touted on the Internet and media spaces. Focus on companies whose modus operandi you understand. Get all the information you possibly can on the company—assets, management, contracts, revenue, debts, and lawsuits. The shiny object syndrome can be a real danger for investors. Penny stocks are volatile, so you would be better off sticking to what you know and understand.
Diversify Your Portfolio
Penny stocks have a higher risk to reward ratio than regular stocks. Your prospects are better if you spread your investments across several companies. How wide you should cast your net is a matter of opinion. However, buying penny stocks in a couple of financially healthy companies would better your chances of getting profit from your investments.
Concentrate on High Volume Penny Stocks
Penny stocks already have a reputation for illiquidity. A smart trader wants to be able to get out of a holding position as soon as the need arises. Trading in low-volume stocks will make this difficult and could cause you to suffer losses as a result. Instead, focus on high-volume stocks.
Don’t Get Attached to Your Stocks
Cynicism should be a critical tool in your stock trading arsenal. Selling companies will always tout their stocks as the next big thing. You don’t want to believe everything you hear from companies and their representatives. Everyone is usually trying to raise their share prices and make a profit for themselves. Do your research and trust your gut. If you feel you have to dump your penny stocks, do not hesitate.
Is There a Right Time To Buy or Sell Your Penny Stocks?
There is no set time to buy or sell a stock. Your ability to identify stock patterns and indicators should guide your investment choices. Every trader has a preferred mode of pattern analysis. Ultimately, the trading decisions on whether to hold or sell your stocks are yours to make. Take profits when you can and manage your risks wisely. Most importantly, as mentioned earlier, you should only invest money you can afford to lose.
Identifying Stock Patterns
In stock trading, observable trends become evident after watching a market for a length of time. Experts can then derive helpful trading patterns and strategies from these observations. The many graphs and charts associated with the stock market model these trends.
That said, no pattern is foolproof. Sometimes, identification of patterns can also be a subjective affair. However, some patterns have proven to be more consistent than others. Some of the more reliable patterns include the following.
The candlestick pattern is a Wall Street favorite. This pattern shows that an existing trend is about to change. Stock on the rise will be expected to fall (or vice versa) in the immediate future. The candlestick pattern is of Japanese origin and has several variations like the Doji, the Harami, and the engulfing candlestick patterns.
Bottom out Pattern
This pattern appears when a stock price has been on a downward spiral for a long time and suddenly stabilizes, especially with a surge in trading volume. Traders can infer that the price is about to rise steadily and will begin to buy the stock.
Top out Pattern
The top-out pattern is more or less the opposite of the bottom-out pattern. If a stock price has been rising for a while, a sudden price stabilization will signal a drop. This signal will lead traders to quickly begin to sell, causing a further loss in the share price.
Traders observe the gap up when a stock opens at a higher price than the previous day’s high. These gaps are usually not a result of trading. They could result from a sudden change in the management or prospects of a company. If a stock peaked at $3 the previous day and opened at $3.6 the next, then there is a gap up of 60 cents. Traders who can figure out the reasons for a gap can quickly use them to their advantage.
Buying the Dip
Rising and falling prices are a regular feature of financial markets. Investors can begin to purchase a stock when it enters a downward slide with the expectation of profit when shares prices start to go up.
Some Other Indicators
In addition to trading patterns, there are other indicators of penny stock’s potential profitability.
Thoroughly research any company in which you want to invest. A look at their cash flow, buyout potential, assets, and debts can give you an idea of potential stock viability.
A study of the life cycle of an industry can indicate the right time to invest. Industries typically go through a life cycle consisting of five stages: startup, growth, shakeout, maturity, and decline. The duration of time these stages varies. Industries between the startup and growth-stage see a rise in profitability. Improvement in product or service delivery sees the company begin to get public attention. Demand usually begins to grow at this stage, and astute investors would be poised to take advantage.
A Surge in Trading Volume
An event like the launch of a new product or service will generally increase trading stock volume. More often than not, it is the sign of an impending upward trend and could be an excellent time to start buying those stocks.
They Continue To Generate a Buzz
A company whose product or service is the talk of the town might be worth the risk. The public attention is especially useful if you are looking at short-term gains. Buzz from the media and other sources can cause share prices to gain momentum. An example is the buzz generated with marijuana stocks due to its recent legalization in some developed countries.
The Reputation of Owners
A company whose managers have proven to be astute businessmen in the past will most likely repeat their feats. You want to invest in stocks managed by people with a track record of making profits.
Increased market share
If a penny stock is steadily gaining market share, it is usually a good sign. It means that the product or service is getting customer acceptance.
Investor Attitude Towards the Penny Stock
When renowned investors start to warm towards a penny stock, chances are it has good prospects. These pros stake their careers on their bets, and banking on their judgments might be a smart financial move.
Nothing is certain with penny stocks. Their volatile nature and the fact that they are not as strictly regulated means the potential for loss is always high. However, with sound analysis, with a keen eye for trends and indicators, and with a sliver of good fortune, penny stock trading can be a worthwhile venture. So how might you go about doing it?
Penny Stock Trading Apps
There are a lot of penny stock trading apps out there. These apps are designed to help you obtain quotes quickly, execute transactions, and learn about the latest news in the penny stock market.
What should you look out for when choosing an app? Ease of use should be paramount. You want an app that has an easily navigable interface. An ideal app should also be compatible with all your devices. Penny stocks are cheap, so you might want to consider the cost. Spending a lot on an app for them is not a smart financial strategy.
Below is a list of some of the most popular apps and their features.
Robinhood is the app for you if the cost is your primary consideration. Using the app is free, even when you execute transactions. However, you can only access listings on the major stock exchanges. OTC stocks and the pink sheets are not accessible with this app. Robinhood can only work on a mobile device.
TradeStation is an efficient, easy-to-use trading app that is usable on desktop and mobile. There is a monthly $5 flat fee that lets you access OTC listings. There is an alternative per share payment plan (0.5 cents per share) and an unbundled pricing package (0.02 cents per share), either of which you can opt for, depending on your trading volumes. TradeStation requires an account minimum of $500 before you can trade with them.
Large brokerage firms also have their own apps. With Schwab, you can access OTC and some pink sheet listings. Charles Schwab is also renowned for its excellent customer service, which lets you speak with an employee if you are unclear about an issue. Schwab is a reliable and easy-to-navigate app. There is no minimum account balance requirement, and it’s available on the web, mobile, and desktop. Charles Schwab takes a commission of $4.95 every time you buy or sell a stock.
The Fidelity app is available across a range of platforms and has no minimum account balance requirements, but it does cost $4.95 per trade. Fidelity stands out because of the extra protection it offers to investors. A representative will speak to you about the risks of your investment. You will only be allowed to trade on the platform after you have acknowledged your understanding of the risks involved in your investment.
E-Trade is a highly-rated trading app. Users can access the app via the web, desktop, and mobile. E-Trade investors will get access to several valuable trading tools and indicators (free streaming market data, stock screener, free real-time quotes, market live commentary, and more). E-Trade is the app of choice for active traders. You will pay $6.95 per trade. However, you only have to pay $4.95 if you execute up to 30 trades within three months.
Can You Get Rich Trading Penny Stocks?
The objective of every investor is to make a profit. Penny stocks continue to rise in popularity because of their minimal entry requirements and potential for enormous profits. However, you must understand the pros and cons of any investment you want to make. You can become a millionaire trading penny stocks, but you are likelier to lose your money.
Unless you are a lover of high-risk investments, penny stocks are not for you. There are safer ways of earning more money without risking financial ruin. There’s an additional risk to consider, one that’s somewhat unique to penny stocks and that has nothing to do with the volatility of the market: scams.
Penny Stock Scams
Fraudulent activities are commonplace in the penny stock market. Stock volatility, risky penny stocks, and less stringent regulatory mechanisms make them a juicy target for scammers. If you want to avoid losing money, here are some of the most common scams to be aware of.
Pump and Dump
The most common penny stock scam is the “pump and dump.” Here, unethical stockholders promote their stocks (pumping) and sell as soon as the prices soar (dumping). Unwitting buyers will be left with significant losses when the market stabilizes. Scammers promote their stock by anonymously emailing newsletters or posting “hot tips” on Internet pages. Paid and dubious promoters are also used to spread false information.
Companies that sell shares to foreign investors are not mandated to register with the SEC. Scammers can buy shares from these unregistered companies at low prices and resell them for huge profits while posing as foreign investors. A glut of inflated and unregistered shares will cause a marked drop in price, leading to enormous losses for their unsuspecting buyers.
Self-acclaimed experts can lure unwitting investors with false promises. These “gurus” will promise to reveal foolproof strategies for payment. You may also be asked to pay a membership subscription fee to become part of an “exclusive club.” Purveyors of these schemes are up to no good. You should avoid them.
In short, a stock trader should be vigilant. Be wary of offers that sound too good to be true, because they most likely are. And if you discover a scam, make a report immediately to your broker or the SEC. It is everyone’s responsibility to ensure that the stock market is fraud-free.
Penny stocks are volatile, high-risk stocks with the potential for a massive payout on relatively little capital. Most investors in penny stocks are bound to lose their money. A shrewd investor will only put in money they don’t mind losing. If you’re investing, ensure you are aware of the risks and potential benefits. An investor armed with sufficient information has a better chance of making a profit from penny stocks.
Are you considering trading penny stocks? Have you already tried it? What has your experience been? Share your thoughts with us in the comments section.
Additional Reading: Secure Your Future with Commission-Free ETFs