Quick Start Guide For How To Start Trading Penny Stocks
If you would like to learn how to start penny stock trading, you aren’t alone. Many new investors are tempted by the allure of penny stocks. Penny stocks offer the potential of overnight success with low initial cost. I can assure for every single success story, there are nine failure stories. The price point is the biggest allure for investors. If you see a stock that is 50 cents with massive hype projecting it moving to five dollars in the next 18 months, that sounds too good to be true.
Have you ever watched the scene in “The Wolf of Wall Street” where the character, Jordan Belfort, walks into the penny stock trading firm called Investor Center? This is the scene that I think of whenever I think of penny stock trading. I’m not suggesting that all the stocks traded over-the-counter (OTC) are actually worthless, there could be several that actually have untapped value. I’m only suggesting that we need to make sure we do as much research as we can and learn the best way how to start penny stock trading.
In this article, I discuss what penny stocks are and the tiers associated, where you can trade penny stocks and the potential risks, then finally a quick strategy on how to start penny stock trading.
What Are Penny Stocks?
Generally speaking, a penny stock can be any stock that is under five dollars in cost per share. However, these penny stocks between one dollar and five dollars are more often than not traded on the national exchange. This means they are regulated by government agencies. There are other tiers of penny stock that range from one dollar to one cent and even in fractional cents. Yes, penny stocks trade as low as .0001 per share. This can be very appealing considering an investment of 10,000 dollars will buy you 100 Million shares and if that stock goes to .0010, then the value of your position becomes 100,000 dollars. With just that one decimal place move.
Now, this may sound very exciting, but keep in mind that penny stocks are actually more risky than regular stocks. For the purpose of this article, I am referring to penny stocks as anything under one dollar per share. These are usually start up companies that are trying to acquire capital and do not meet the listing requirements to trade on the larger exchange. In that manner, penny stocks will usually trade via the Pink Sheets or Over-the-counter bulletin board (OTCBB).
These are both electronic trading platforms that connect buyers and sellers. Companies listed on the Pink Sheets are not required to disclose any financial statements. This means that they could be completely bankrupt or have very small operations. They will usually have low liquidity, and if a trade is placed, it could take hours for the order to fill or may not fill at all.
Where Can You Trade Penny Stocks?
Now that you have better understanding of what penny stocks are, I’m sure you are asking, “where can I trade them?” Well, the stocks between five dollars and one dollar can be traded in any brokerage account as long as they are listed on the actual New York Stock Exchange. You can trade stocks that are less than one dollar at many brokerage firms as well. Examples that I would suggest are Charles Schwab, Fidelity, E-Trade and TD Ameritrade.
But if you want to venture into the world of sub-penny stocks traded on the Pink Sheets, then that can be a little more difficult. These may be traded at the brokerage houses, you would need to talk to their customer service. Some charge additional fees for smaller trades. A website to learn more is OTC Markets Group. I have also recently learned about Webull for trading as well.
Market Strategy: How To Start Penny Stock Trading
If you would like to start trading penny stocks, I would suggest strongly following the next five steps. These are going to be similar to my article on ‘Stock Market Investing’ with some nuances.
Step 1 in Strategy: Select the trading platform
This can be as easy as choosing a brokerage firm that you like the best. Another quick way is to just do an internet search on “Best Online Brokers to start penny stock trading”. The top 5 that I see, in no particular order, are Interactive Brokers, TradeStation, Lightspeed, Fidelity and Charles Schwab. The major piece to this section is fees. We need to focus on how much these firms charge for penny stock trading. Many firms don’t charge commissions, so we need to select one that doesn’t charge commission.
Step 2 in Strategy: Research, Research, Research
This is really the main category. You hear me talk about financial education in many of my posts. When deciding on what to trade, research is so important here. There is a lot of hype around penny stocks. More so than traditional stock day trading. Exchange listed penny stocks are much safer to trade. There are multiple companies that are less than one dollar that may prove to be financially sound. Conversely there are many out there that are not. There are many ways to screen for stocks that are under a dollar. Typically, this can be found in the research section of the online platform.
Personally, I would discourage trading in the Pink Sheets or OTCBB. Most brokerage houses can trade these but this would require some additional conversation with customer service and may take some time to fully execute. The big question mark with trading on the Pink Sheets or OTCBB is that there is no regulation. They are very possibly scamming people and there is no way to know. At least with listed securities that are under one dollar, you can do more research on the company. There are requirements to be listed on the New York Stock Exchange.
Step 3 in Strategy: Monitor the Volume
I would strongly discourage buying shares of companies with little to no volume, regardless of the price. Many penny stocks trade less than five thousand shares per day, but if there is a special news release on the company, it could trade in the millions. These could be better days to trade penny stocks as the liquidity of the stock is much higher.
Step 4 in Strategy: Stay away from the random Emails!
When you start your investing journey, inevitably there will be some eye catching guru talking about what stock to buy or the latest stock to purchase. I personally find the ones that mention, “the next Google” or “Better than Apple” to be quite humorous. Promotional offers can be extremely risky. Now, if someone is offering a program to teach you a trading strategy, that may be worthwhile. There is great value in learning from someone who has been successful in that field. Most wealthy people have a mentor. Everyone builds upon something that someone else has first created.
Step 5 in Strategy: Manage your risk
This should go without saying really. But since we are talking about penny stocks, there are only a few ways to really manage risk. Penny stock trading is highly speculative. It’s very similar to actual gambling. There is typically limited news, liquidity, and general insight into the company. We shouldn’t use penny stock trading as our only source of investment income.
That being said, one of the biggest ways to manage risk in trading is to set a profit or loss threshold. It’s best to get small gains consistently with penny stocks to avoid the potential downturn. We learned about stop orders and limit orders in my post on ‘Trading Stocks‘. Penny stocks are not necessarily good for a buy and hold strategy. Also, make sure to have safer, less volatile investments in another account. Lastly, if you really want to learn how to start penny stock trading, join a trading chat room or look for a course on trading penny stocks.
My Final Take
I’m sure many of you can tell by now that investing is a passion of mine. Trading and investing was my first exposure to making real money online and outside of a day job. With that said, penny stock trading is very risky. I am no stranger to risk and have done a fair amount of penny stock trading in my past, but I would really caution a new investor in doing this. You really will need a great deal of patience and risk tolerance. Plus, you will need to be able to make quick decisions that affect your investments. For some more information on trading penny stocks, check out this book, “The Guide for Penny Stock Investing” by Donny Lowy. This book goes over some of the risks and also ways to spot trends for huge growth penny stock companies. Another book option is, “Invest in Penny Stocks: A Guide to Profitable Trading” by Peter Leeds.
All investing comes with risk, but penny stocks add a little extra. I would suggest talking to your brokerage firm about getting a trading simulator and experimenting first in a risk-free environment before diving in to the deep end. Also, keep in mind that many brokerage firms have the ability to invest in fractional shares of stocks, so you could benefit from that appreciation even if you don’t have enough cash to purchase a full share. I hope this gave you some more information to enhance your trading knowledge or spark an additional interest. As usual, Happy Trading!
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