Beginner’s Guide to Penny Stocks

Thu Jul 9, 2020, 04:33 pm | by Delaney | No comments

Penny stocks are a hot topic among day traders. They are stocks with small share prices, making it easy to buy large amounts of them and gain a large profit. However, you also have a greater risk of losing the money you invested. This guide will break down what penny stocks are, the differences between these stocks on different exchanges, and more.

What Are Penny Stocks? 

According to the United States Securities and Exchange Commission (SEC), penny stocks are usually securities that trade $5 or less per share. Despite the term, not all of them trade for pennies as the name suggests. However, some people do consider true penny stocks to only trade under $1.00. 

 These stocks are typically small companies and usually trade on over the counter exchanges. However, some do trade on the NYSE and NASDAQ, which offers more regulation. The major exchanges require stocks to trade over $1.00, however, companies usually are given a notice to get their share prices above $1.00 before they are delisted.

Penny stocks are small companies that may not already have a successful business. Often, these companies spike up on the volatility of a single news catalyst, which can provide a big opportunity for gains, but also massive losses. That’s why it is very important to practice and do research prior to trading.

Remember, never risk money you can’t afford to lose when trading, especially when it comes to penny stocks. 

Trading Penny Stocks Over-the-Counter vs. Major Exchanges

There are two main ways penny stocks often trade: over-the-counter (OTC) or NYSE and NASDAQ. The main difference is that stocks that trade over the counter don’t always have to follow strict requirements and regulations that the major exchanges have. Additionally, the major exchanges require shares to trade above $1.00, though usually issues a warning before delisting. 

Warrior Trading recommends avoiding OTC penny stocks, since they don’t always provide proper financial documents, trade under $1.00, and usually lack liquidity. You can still trade ones that are listed on the NYSE and NASDAQ.

It’s up to you whether or not you want to trade these type of stocks on the OTC markets, but they can be especially volatile and should be traded with caution. 

What are the Risks?

Penny stocks are speculative and typically lack liquidity, and can be hard to sell shares once you won them. You can easily gain money in your position, however, losses can be substantial, especially if you are trading on margin. 

Additionally, due to low liquidity, it can be hard to find an accurate price quote on these stocks. 

Many companies with penny stock share prices are small businesses looking for funding. There may not be much credible information available to make an informed decision than a more established company has. 

An additional risk about trading on the OTC exchanges there is no standard requirements, unlike the major exchanges. When a company is delisted from a major exchange, it usually trades on an OTC exchange. 

It is also important to be aware of the possibility of the company approaching bankruptcy, or pump and dump schemes that try to draw traders into buying. Pump and dump schemes often come in the form of people heavily promoting a stock, then they sell their shares, dropping the price significantly.

Trading Penny Stocks

Once you’ve learned about penny stocks, you will want to practice them through paper trading. That way, you can practice without risking real money.

You must be educated about the markets and penny stocks to trade them successfully. Remember to stick to your trading plan, and make sure you don’t risk any money you can’t afford to lose. 

Due to the risky nature of this type of stock, it’s important to be prepared, especially if you are trading on margin. Research the company before trading, stay away from scammers promoting stocks that could lead to a pump and dump, and look into how liquid the stock is. Liquidity is important so you don’t get stuck in a trade for days until a buyer is found. Make sure to determine your stop-loss order before entering your trade. Know when you want to exit the trade to prevent high losses. 

When you’re ready to trade penny stocks, a Screener or Scanner is going to be your go-to tool. Not only can you screen for stocks under a certain price range, but you can also include other screening filters to fit your strategy and risk tolerance.

Final Thoughts 

Although tempting, penny stocks are not for the novice trader. They are highly volatile and can bring large gains and losses. It’s important to be educated not only on trading penny stocks but on the stocks you’re looking to trade.