How to Trade Penny Stocks
Penny stocks have generated life-changing gains for some, but others have been burned by these assets. We’ll cover how to trade and stay safe.
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Yes, you can buy stocks with pennies.
But is investing in super cheap stocks worth your hard-earned pocket change?
Anyone interested in investing has probably heard a lot about penny stocks—and those seemingly mythical stories. Someone starts with a couple thousand dollars, throws it all into some risky asset, and suddenly has a cool $25 million.
Even though it seems too good to be true, it does happen (sometimes).
So, can you smell your lamborghini already 🏎? is it time to throw your life-savings into penny stocks, close your eyes, and hope for the best? The answer to that is a hard no.
With a low price comes high potential risk—if the company you invested in goes bankrupt, that might delay the purchase of that Lambo. That’s why you need to know how to spot worthless stocks (which are aplenty) and only focus on what can make you money.
In this guide, we will help you understand penny stocks, what they are, how to buy them, and due diligence to stay safe and avoid scams. As with all speculative investing, only use money that you can afford to lose.
- What is a Penny Stock?
- Is Trading Penny Stocks Profitable?
- Are Penny Stocks Good for Beginners?
- Trading OTC Penny Stocks
- How to Buy OTC Penny Stocks
- The Different Tiers of Penny Stocks
- How to Research Penny Stocks
- Day Trading with Penny Stocks
- Popular Types of Penny Stocks
- How to Start Trading Penny Stocks
- Key Tips for Penny Stock Trading
- Penny Stock Trading: FAQs
What is a Penny Stock? 💡
Penny stocks are the shares of low-value companies. While some are like the other assets that you can purchase on the NYSE or NASDAQ, others aren’t even listed on an exchange. But they all have one thing in common: they are cheap. At the high end, penny stocks are worth $5, and they go all the way down to fractions of a cent.
Penny stocks that are available from a national exchange can often be purchased through your broker. The ones that are not on an exchange have to be purchased over the counter (OTC), these are sometimes called Pink Sheet stocks. OTC stocks can be purchased through some of the top stock trading platforms, such as Fidelity or Interactive Brokers, depending on your account-type.
Penny stocks can be risky assets because the share price has decreased to such a small amount for a reason. And whether you are buying a business that has existed for several decades but has seen a recent decline, or a new company selling OTC that doesn’t want to comply with exchange regulations, you are exposed to some risk on these markets.
Is Trading Penny Stocks Profitable? 💸
Trading Penny stocks can be lucrative. Some traders can live entirely off the money they make from trading and make tens or even hundreds of thousands of dollars. On the flip side, a report from the SEC in 2016 shows that traders in OTC assets could be losing as much as 60.3% of their investments every year.
What’s the deal? How can some investors make so much off these assets, while others are blowing up their investment accounts? For the most part, it comes down to research.
It may be tempting to invest in weed penny stocks that you think will explode in value in a few years. But the blind leap of faith isn’t going to do you any favors when it comes to trading. You need to analyze stocks, understand their underlying fundamentals, what the cash flow looks like, and if the business is sustainable.
Otherwise, you are better off going down to the gas station and buying lottery scratchers. If you are looking for safe investments that will guarantee at least average returns, you should look into S&P 500 ETFs.
The Good and the Bad with Penny Stock Trading
Pros
- You can buy shares for under $5
- Low stock price means you can see your investment multiply many times
- Stocks may not be analyzed by institutional investors; it’s easier to find undervalued assets
Cons
- It’s easy to lose money on penny stocks, especially OTC ones
- You are exposed to “pump and dump” scams
- Some companies that aren’t comfortable with exchange reporting standards may have real issues with their company
Are Penny Stocks Good for Beginners? 🌱
The best assets for a trader are going to depend on several factors such as the time of day you will be trading, the amount of capital you are investing, and your risk tolerance. While some investors may find penny stocks profitable, others are better off trading forex, futures, or regular stocks.
If you are new to trading, you should read up on how trading works and affects your finances. When you trade, you are exposing yourself to numerous risks and this includes increasingly volatile penny stocks.
Many small-cap penny stocks represent a company with low enterprise value. This means that a company will be more susceptible to downturns in business and the economy. A large or Mega-cap company such as Amazon is less likely to face these same issues (but sometimes you get tired of feeding Jeff Bezos’ fortune 🥱).
Penny stocks are also vulnerable to “pump and dump” scams. These scams occur when a shareholder encourages other investors to buy a stock and then sells their position when the price has artificially risen.
Alternatively, traders can avoid some of these problems by trading forex. This asset also has a low cost of entry with some brokers allowing you to open an account for just $50.
Trading OTC Penny Stocks 🔎
Over-the-counter (OTC) penny stocks are by far the riskiest kind of penny stocks, with a few notable exceptions. OTC stocks are sold and listed through decentralized trading networks instead of a standard national exchange. This allows smaller companies to be listed, or companies that don’t want to deal with government oversight on their finances.
Reasons Companies are Sold Over-the-Counter 👇
Company Type | Reasons Companies Are Sold Over-the-Counter |
---|---|
Smaller Companies | Some small companies don’t have the administrative overhead to deal with the fees and paperwork that go along with listing on a national exchange. |
Non-U.S. Companies | There are some major corporations that are traded through the OTC network simply because they do not want to deal with another regulatory agency in addition to their own country's regulator. Some examples of this are Nintendo, Bayer, and Volkswagen. |
Delisted Companies | Companies can be removed from an exchange if their stock price falls too low. On the NYSE, companies are delisted after their price drops below $1. |
Fraudulent Shell Companies | There are some listings on the OTC markets that are illegitimate shell corporations. These companies have no underlying company and represent no real investment, but instead are used to defraud investors by selling shares. |
OTC stocks are managed by OTC Markets. The company offers some warnings about risky stocks, including various grades, banners, and symbols to help you avoid fraud.
How to Buy Over-the-Counter Penny Stocks 🏛
Investors who are interested in trading OTC penny stocks should find a solid penny stock broker that fits their investing style. Some brokers will let you buy the assets with your usual investment account, others will have you request access to OTC listings specifically, and a few charge commissions for these stocks.
If your online stockbroker does not offer OTC investments, then you may need to find an in-person brokerage that has an inventory of over-the-counter assets to sell. Because OTC assets are not listed on a national exchange, there is not as much information on bid and ask prices for these companies. In many cases, you will be subject to the information that your broker has.
Are OTC Penny Stocks Safe? 🦺
Arguably the number one reason to avoid OTC penny stocks is to avoid being scammed. The SEC offers advice on avoiding the scams that occur regularly in the OTC market, but navigating these murky waters is still energy-consuming.
Investors should be wary of increased publicity on a company. They should also avoid companies that change their name often, have no real business operations, and see sudden spikes in trading volume out of nowhere. It doesn’t take a financial genius to see some of the scams from a mile away. 🕵️♂️
With all of that in mind, it is possible to make money on the OTC markets; you will need to be extra cautious with trades. If you are trading large-cap foreign companies, fraud is less likely than if you are trading in some company that popped up overnight and has no real financial information.
The downside of the OTC Penny Stock market is that there aren’t many protections for investors. Companies are not required to disclose any information about their company, so you won’t be 100% sure what you’re buying into with some stocks. Even if you do have enough information to make a good trade, you should know that there is some evidence that long-term investments will outperform short-term trading.
Tiers of Penny Stocks 🗂
Because of the wide range of information and quality on penny stocks, with some offering no information and others being transparent, some traders find it helpful to classify stocks into different tiers. This is designed to help traders better calculate risk when entering into a trade.
Tier 1 Penny Stocks 1️⃣
Tier 1 penny stocks are publicly listed companies that have not been removed from exchanges. These companies are trading at less than $5 per share, but they haven’t yet hit the threshold of $1 to be delisted.
Tier 1 penny stocks are safer than OTC stocks because you are less likely to be scammed by a shell corporation. These companies are reporting their earnings and other financial information to the SEC, and so you have a better chance of understanding the whole story of a company. You will also be able to see why the price of the company has fallen so low.
Tier 2 Penny Stocks 2️⃣
Tier 2 stocks are still traded on national exchanges but they are close to being removed. There is normally a lag between when a company’s shares fall beneath $1 and when they are delisted. Exchanges will inform companies of the date when their stock will be delisted, and exchanges will make investors aware of that date.
This provides a great opportunity for investors to trade on a volatile asset before a company is moved to an OTC market. If the company does not keep its price above $1 by the date stipulated by the exchange, the stock will be delisted.
Tier 3 Penny Stocks 3️⃣
Tier 3 stocks are traded under $0.01 and will not be listed on any exchanges. You will have to buy these on the OTC market and there is little to no oversight on the information these companies report to investors.
Tier 4 Penny Stocks 4️⃣
Tier 4 stocks are trading between $0.0001 and $0.0009. These companies are incredibly cheap and are infamous for scammers. Even small movements in the price of these stocks can represent the potential for huge gains. Investors should be wary of advertisements or promotions for these kinds of assets.
Because of the incredibly cheap price of the asset, someone can very easily purchase millions of shares in a company. When looking at these stocks watch out for trade volume to see if investors have only been active recently. Overall, you should avoid these companies.
How to Research Penny Stocks 📚
Finding the right stock to buy is the constant question that all investors ask themselves. If you want to find the right penny stock to day trade then you will need to be familiar with technical analysis. Along with this analysis, you will want to use a screener to find stocks that meet certain criteria.
Pre-Market Movement 🕗
Depending on whether you are buying or even shorting a stock, you can look for companies that are gapping up or down in the pre-market. This is a common way to find stocks that have increased volatility – and volatility is where you can make a profit.
Float ⛵
Besides pre-market gapping, you should evaluate the float of a company. Float is the total outstanding shares that a company has sold to the public for trading. A lower float means that trades will likely be more volatile because there are fewer shares to go around. This can help accelerate trends.
Volume 🥛
Watching the volume of a stock can help you understand more about its volatility. A stock with high volume will have more trades active on the exchange, this improves liquidity and your potential for profit.
How to Day Trade Penny Stocks ☀️
To day trade penny stocks you will need to learn the basics and find the right day trading software to get you started. You have to learn to handle your emotions, get rid of your FOMO, and treat day trading as a serious, full-time job.
Day trading is difficult and can take years to learn properly. However, it is possible to make a living off of just trading. Instead of chasing giant returns and risking a lot of your account on one-off trades, try to start by creating a strategy that accounts for the likelihood that you will lose some money.
✅ Follow a few simple rules when you start day trading:
1. Only risk around 1-2% of your account on any one trade. This helps you stay in the game longer—and it will help stave off greed. Of course, only risking a small percentage of your account on trades means that your profit potential is limited. It is easier to make money day trading when you have more capital to start with—keep in mind that the lowest legal requirement is $25,000, so you need more money to day trade properly.
2. Set limits for yourself on when you will exit a losing trade. Learning to use stop loss orders and trailing orders can help you offload downtrending stocks automatically.
3. Take your profits while you can, set a goal in mind. You should have an idea of where you want to exit a trade before you enter it. This will help keep you profitable in the long run.
⚡️ Quick tip: Setting target percentages that are higher than your loss percentages will keep your account in the green even when you have the same number of winning and losing trades.
4. Define your strategy and be consistent. One of the most important aspects of being a day trading is sticking with your plan. If you change your trading strategy you are bound to lose money. This is especially true if you are trading emotionally.
Popular Types of Penny Stocks 🙌
Some penny stocks offer an increased incentive for investors because they are more likely to turn out significant gains in the long term. These assets are often in industries that have high valuation speculation, or they are just really solid businesses. Finding the right stock can be a challenge, and you should try to diversify to avoid unnecessary risk from any one company.
Cannabis Penny Stocks
Cannabis stocks, more commonly referred to as weed stocks, offer great potential for growth as the U.S. and other countries decriminalize and legalize medicinal and recreational marijuana. The anticipated growth has been highlighted by large spikes in weed stocks by investors.
As we saw with the HITI stock which jumped from the $0.10 – $0.20 range to $0.60 and beyond, investors can make large gains in this sector. A 6x return on your investment is lucrative, however, marijuana penny stocks are still risky and should not be taken lightly.
Tech Startups
Tech startups offer great potential for growth because they are one of the most dominant industries in the market in general. When startups come along they can generate lots of profit depending on their particular sector. However, startups can have problems delivering in the long run.
One popular recent tech start-up is KRKNF. The tech company has already introduced the potential for nearly 100% gains for investors. On the other hand, some companies come out with a great, innovative technology, which is also impossibly impractical—they usually fail after a brief period of rapid growth.
Stocks with Strong Fundamentals 💪
If you believe in the long-term growth of a company, then you should invest a safe portion of your portfolio into it. Keeping your investment ratio reasonable helps secure the health of your account if the stock goes bad later.
Fundamentals will normally only be available for stocks that are listed with exchanges like the NYSE or NASDAQ. If a company is being traded as an OTC stock then it is difficult to verify the information the company provides.
High Volume Stocks 📊
High volume stocks will be very liquid. This makes it easier to enter and exit trades. High volumes also means that there is a lot of interest in a stock. That means you’ll be exposed to bigger swings in the market.
Highly Volatile Stocks ⚖️
Along with high-volume stocks, volatile stocks present an increased chance of profit. Using simple technical analysis it can be easy to trade breakout sessions of the stock. Profit in day trading comes from small price movements—volatility fuels these movements. Use your stock screener to filter for these companies.
How to Start Trading Penny Stocks 🚀
All asset types come with a certain number of loops one needs to jump through before actually investing. This is also the case of penny stocks, so here is what you need to know to start building your portfolio of dimes and nickels in an easy and cost-effective way.
Find a Brokerage 🔎
Trading penny stocks will start by finding a brokerage. In recent years, traders have even been able to start trading on their mobile phones, which is great since trading apps have a similar functionality to their desktop counterparts. You will want a brokerage that offers the kinds of tools, as well as graphs you need to trade effectively.
A good broker like TradeStation will help you avoid slippage and can offer great research tools for trading. You will also need to keep commissions low to avoid having your profits chewed away.
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Risk and Planning ⚠️
Planning how much you are willing to risk is essential when it comes to day trading. If you can afford to invest more, then your potential to gain goes up. However, you should only invest as much as you are willing to lose.
After you have determined your risk, try to develop your plan for trading. Figure out whether you will be holding stocks overnight, whether you will be trading breakouts, and how much you are willing to lose on a trade. It’s also important to decide how much you plan to make on your winning trades.
💡Remember: Deciding whether or not penny stocks are worth it, all depends on the level of risk you’re able to take on.
Devise a Strategy and Stick to it 🧠
Penny stocks are volatile and that will pose an increased risk to emotional investors. Once you start losing money on a trade, you need to have an idea of your maximum comfort level. Don’t hold on to stocks thinking they have to come back up.
Emotion can cause losses if you are trying to chase gains to make up for money you have already lost. When you are emotional, your decision making ability is impaired. If you are trading emotionally you may need to end your session for the day to avoid greater losses.
Paper Trading to Real Trading ✅
Some new traders find it helpful to start day trading by using a paper trading account. Paper trading allows you to use data from the stock market to practice your strategies with virtual money. While this kind of fake trading can help you nail down a strategy, many people find it different from real trading because it is less emotional using fictional money.
After you have nailed down your strategy, it’s time to start trading for real. Start with small trades and work your way up to your risk tolerance.
Tips Every Penny Stock Trader Needs to Know 🚨
Having all the theoretical know-how in the world is great, but it’s also not a bad idea to step into the game with some good-old wisdom. Here are a few tips that every new trader will likely hear from their mentors.
- Stay away from companies with very little information – The less information a company has, the greater risk you take in buying it. Avoid these companies because there are many conmen in the micro-cap stock industry.
- Be cautious of pump and dump scams – When a particular stock is being promoted you should look at the fundamentals and the trade volume. Sudden spikes are often indicative of pump and dump scams.
- Stay unemotional – As hard as it may be, the easiest way to lose money as a day trader is to let your emotions call the shots. A cool head is what separates smart traders who fail from smart traders who make money.
- Avoid discords or text groups that tell you when to buy a stock – These are the breeding grounds for pump and dump scams. Oftentimes, the people who run these groups will have already bought up thousands of shares of the stocks they are telling you to buy.
- Don’t get greedy – It’s as simple as that. Know when to take your profits. It’s better to make only a little bit of money than to lose any.
And there you have it! If you’ve made it this far, pat yourself on the back—you deserve it. You now have a solid foundation to enter the world of penny stocks.
Remember the tips above, try to keep emotions out of it, and never invest what you’re not willing to lose!
Penny Stock Trading: FAQs
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Can Penny Stocks Make You Rich?
Penny stocks can make you rich but smart investors should minimize risk and avoid poorly diversified portfolios. Penny stocks will often require active investing to avoid losses so the chances of getting rich with a passive long-term penny stock investment are very low. Penny stocks are ultimately one of the riskiest forms of stock trading available.
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How Can I Buy Marijuana Penny Stocks?
You can buy weed stocks through several popular stock brokers. If the stocks are trading above $1, they may be listed on the NYSE or NASDAQ. Otherwise, you will have to buy shares through the OTC market.
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How Can I Short Penny Stocks?
Investors short penny stocks by borrowing shares from their broker and selling them. They then attempt to make a profit by buying the shares at a lower price than they sold them for. You can initiate short sales through a brokerage.
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How Do I Find Penny Stocks Before They Explode?
Finding a penny stock before it explodes takes time and knowledge of company analysis. You should evaluate companies using a screener and looking for indications of solid fundamentals. It can also be useful to follow company and sector news.
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What is the Most Successful Penny Stock Ever?
Some of the most successful penny stocks of all time are common household brands like Amazon and Apple. Both of these companies initially listed under $5 and then went on to be the biggest corporations on the planet.
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How High Can a Penny Stock Go?
The upper limit of penny stocks is theoretically unlimited. However, some of the most successful penny stocks in history are companies like Amazon and Apple. These stocks went from under $5 to a couple of thousand dollars per share.
All reviews, research, news and assessments of any kind on The Tokenist are compiled using a strict editorial review process by our editorial team. Neither our writers nor our editors receive direct compensation of any kind to publish information on tokenist.com. Our company, Tokenist Media LLC, is community supported and may receive a small commission when you purchase products or services through links on our website. Click here for a full list of our partners and an in-depth explanation on how we get paid.