What’s a Penny Stock?
Well, yes—penny stocks (also called micro-cap stocks) describe shares of a company that trade for low amounts, usually between $0.01 to $2.00, and many institutions consider a penny stock to be anything that trades for less than $5.00 per share.
They’re Inexpensive, So What’s the Catch?
Everyone who’s worth his (or her) salt when it comes to the stock market knows that penny stocks equal a bigger risk than regular stocks.
The reason for inflated risk is simple. The companies that hold penny stock typically have no profits and minimal operations. They usually trade on the pink sheets or on FINRA’s over-the-counter bulletin board (OTCBB) and are not required to file with the Securities and Exchange Commission (SEC). These stocks have low liquidity due to a lack of buyers and sellers, so orders may not be filled right away or even at all. In addition, volatility tends to be high among OTC stocks, and bid-ask spreads are frequently large.
Ally Invest, formerly TradeKing has excellent research reports that are crucial to trading penny stocks. Because penny stocks are not covered as widely as other stocks, it is important to have a solid brokerage account with up to date information when making informed trades.
Where penny stocks “get people” is the cheap cost, but also because of the “simple math” of penny stocks: that if you buy shares for $0.20, and if the stock goes up by $0.10, then your profit is at 50 percent—that’s the rosy, pie-in-the sky scenario. However, it’s just as easy (and likely, with these volatile stocks) for your $0.20 share to go down by $0.10 and lose 50 percent, instead.
Therefore, a $1,000 investment could lose value pretty quickly.
So, How Do I Trade Penny Stocks?
Okay, you’ve listened to the warnings, yet you still want to trade penny stocks. Now, it’s still possible to trade penny stocks successfully.
However, first, you need to learn. Then, you trade. You must be an educated investor who understands the market to successfully trade penny stocks. Trust me, the odds are not in your favor if you don’t understand what you’re doing. That being said, though, if you trade penny stocks successfully, they really can offer the greatest risk-reward ratio of any investment type.
The second thing you must do is stay away from scammers. Read the fine print on any email or ad you see on social media and in emails. “Pennies to dollars instantly” is a great lead-in to a major source of pain—for you. If there’s a disclaimer at the bottom of a social media post or an email, someone’s getting paid to post an ad, and you should stay far, far away.
Here are a Few of Your Next Steps:
- Do your research of the penny stock companies you’re interested in.
- Choose a broker. (See next section on affordable brokerages for penny stocks.)
- Determine which stock to trade, and a good starting point is to use tools that exist on the OTC Markets website or Finviz. (Also, know that the OTC Markets Group organizes securities into tiered marketplaces that can help you determine which stocks to trade—which may help you determine potential success with your trades.)
- Begin trading! Be sure you’re comfortable with losing money on some (or potentially all) of your trades.
- Get into a day trading chat room—you’ll be able to learn a ton there, or even better, get a mentor who really knows a lot about trading the stock market.
- Be comfortable making mistakes. Nobody is a great trader right away. A great overview of pennystocking can be found at www.timothysykes.com. (If you’re into penny stocks, you’ve heard of Tim Sykes, who, by the age of 21, turned $12,415 of his bar mitzvah money into $1.65 million by day trading penny stocks.)
Economical Penny Stock Brokers
A little research online will net you quick results on which brokers are the best for penny stock aficionados. A bunch of online brokers charge extra for penny stock trades, which (ironically) makes penny stocks mega-expensive. So, obviously, you’ll want to find the brokers who don’t include extra surcharges on penny stock trades—it’s worth it to do some digging.
A couple of brokerages that surfaced were TD Ameritrade and TradeStation, which charge nothing in surcharges. Per penny stock transaction, TD Ameritrade charges $6.95 and TradeStation charges $5. It’s also worth it to know that TD Ameritrade doesn’t have a surcharge on large orders—around 1,000 shares or more.
Watch out, a lot of brokers enact a surcharge on those large orders. In addition, some also require you to trade penny stocks by imposing limits on the types of trades you can execute.
Final Thoughts on Investing in Penny Stocks
Tim Sykes has been asked the question, “Aren’t penny stocks dangerous?”
He answers, “Yes. And life is dangerous.”
Can’t disagree with that! Ultimately, educated and disciplined individuals can make money on penny stocks—but it takes training, a mentor, and a major willingness to take on risk.