When you hear the term “penny stocks,” something along the lines of small investment with a large return probably comes to mind. While it’s possible to turn a profit without breaking the bank to buy shares, you can also end up on the shorter end of the stick as these investments are quite risky.
Keep reading to learn more about penny stocks and how to get started trading:
What are penny stocks?
Penny stocks are defined by the Securities and Exchange Commission (SEC) as shares issued by small or micro-cap companies for any amount below $5 per share.
They typically trade on the over-the-counter (OTC) or dark market. But you may find some on U.S. securities exchanges, foreign exchanges, and in rare cases, on major stock exchanges.
They are designed for investors who can withstand a high level of risk as the low price point is a tell-tale sign of bigger issues going on within the company. It could be anything from cash-flow issues to impending bankruptcy or fraud. You could also be dealing with a startup with little to no track record or a company with management woes.
Can you make money with penny stocks?
It is possible to make money with penny stocks, but you can also lose a lot of money. Penny stocks are considered a risky investment. So, it’s important to diversify and you should only risk what you can afford to lose.
Most retail investors will have a higher chance of making money over the long term with regular stocks.
How to Get Started with Penny Stocks
Step 1: Do Your Homework
Since you are aware that the low price per share has an underlying connection to something going on in the company, it’s your job to pull back the curtain. Once you’ve done your due diligence and are OK with the riskiness of the shares, you can move on to the fun part; buying or selling shares.
Not sure where to start? Consider reaching out to a seasoned penny stock trader for guidance. They can serve as your mentor and help you avoid some of the same mistakes they made early on.
You can also try your hand at “paper trading” to get acclimated with buying penny stocks. It won’t cost you a dime and will give you a bit more time to decide if you want to move forward with investing in that particular company or penny stocks altogether.
Step 2: Decide How Much You Want to Invest
There’s no golden rule for the exact amount you should or shouldn’t invest in penny stocks. But one thing’s for certain: you should only put an amount on the table that won’t tear apart your finances if you lose your investment.
Why so? Penny stocks are volatile, and “penny stock investors should be prepared for the possibility that they may lose their whole investment,” according to the SEC.
When deciding on an amount, consider the volatility of the industry the company is in. it may be tempting to dump all your hard-earned cash into a company within an industry on the up and up. But be mindful that this could be the result of a short-lived fad and will put your investment at even more risk.
Step 3: Start Trading Penny Stocks
Ready to trade penny stocks? If you’ve done your due diligence and decide to invest on the merits of your research and not a “hot commodity” someone else is selling you, it’s time to start investing in penny stocks.
Even if you’ve done some paper trading, it’s best to start slow with a small amount and buy more shares once you’re comfortable.
Finding Penny Stocks
You can buy some penny stocks on exchanges such as the Nasdaq, but most big exchanges like Nasdaq and the New York Stock Exchange (NYSE) have strict listing requirements. Penny stocks trade over the counter (OTC) and are primarily traded on OTC markets like Over-the-Counter Bulletin Board (OTCBB) and Pink Sheets.
You can find information about OTC stocks on sites like Google Finance or Yahoo Finance or from resources that your broker might offer.
Choosing a Broker
When selecting an online broker, you’ll want to be aware of their fee structure, trade surcharges, volume restrictions, and trading restrictions. Broker fees can cut into your profits, so it’s essential to choose the right one.
Which broker is best for penny stocks?
While we have not created a list of the best brokers for penny stock trading, this list covers the best online brokers for stock trading of 2023. Just make sure before choosing one that they do indeed allow you to trade penny stocks because not all stockbrokers do.
Risks and Considerations of Penny Stock Trading
Before you dive into the world of penny stock trading, there are some risks you should be aware of.
Trade Volume and Fees
It’s no secret. The trading volume for penny stocks is relatively low because of their risky nature, so you may find it difficult to buy and sell at the most optimal times. You also want to pay attention to the fees that brokers sometimes tack on to penny stock trades.
If you find that they are substantially higher than what you’d pay to trade regular shares, move on to brokers that don’t employ this practice.
Exchanges
If the shares aren’t listed on a major exchange, like the NYSE or Nasdaq, proceed with caution as the regulations are little to non-existent. In turn, you have much more to lose as there’s no way to gauge how the company will perform in the short or long term with little information to go on.
Return on investment
When trading penny stocks, there’s no guarantee that you’ll turn a profit. In fact, the odds definitely aren’t in your favor if the company the shares are tied to is in the midst of a financial storm or rough patch.
While this isn’t a definitive nail in the coffin, you have to think about the time between the purchase of shares and when the penny stock price appreciates and if it’s worth the wait. This could take months, if not years.
Scams
Be on the lookout for scam artists that promise to make you wealthy from trading penny stocks overnight. They do this by promoting a particular penny stock heavily or issuing warnings that a particular penny stock should be avoided at all costs. Either way, these deceptive marketing tactics can drive stock prices up or down in a jiffy and wreck your earning potential.
Strategies for Successful Penny Stock Trading
Setting clear goals and risk tolerance
Ensure that you clearly understand your investment goals and risk tolerance before engaging in penny stock trading. This can help guide your decision-making and ensure that you are comfortable with the level of risk you are taking on.
Using stop loss orders and other risk management techniques
Stop loss orders and other risk management techniques can help to limit potential losses in penny stock trading. These techniques can help to protect your investment and keep you from making rash decisions in the face of market volatility.
Being patient and disciplined in decision-making
Successful penny stock trading often requires patience and discipline. This means taking the time to thoroughly research potential investments, avoiding the temptation to chase after quick gains, and sticking to a well-thought-out trading plan.
Penny Stock FAQ
How much money do you need to start trading penny stocks?
It depends on the broker you open an account with. Each broker has different minimum deposit requirements for opening an account. Most of them don’t have any requirements at all.
Are penny stocks hard to trade?
Penny stocks can be volatile and unpredictable. They are also subject to market manipulation. Most active traders who trade penny stocks are day traders. Only about 10% of those day trading penny stocks are actually profitable.
Why are penny stocks risky?
Penny stocks can be highly volatile and are typically subject to greater risks than larger, more established stocks. They may also be more susceptible to fraud and manipulation, which can lead to significant losses for investors.
Is Robinhood good for penny stocks?
You can trade penny stocks on Robinhood. However, the only penny stocks supported by Robinhood are stocks that trade on either the NASDAQ or NYSE. While most penny stocks are not listed on these major exchanges, exchange-listed penny stocks are typically viewed as the safer alternative to OTC stocks.
Bottom Line
Investors that are ok with taking on risky investments and waiting it out may find that trading penny stocks are a suitable way to turn a profit. Otherwise, you could be better off buying stock from an established company that is traded on a major stock exchange to help minimize the risk of loss.
