Penny stocks are a lot different than ‘regular' stocks. But they're also becoming increasingly popular as a way to turn small sums of money into larger amounts fairly quickly. But can you really make money trading penny stocks?
Here's what you need to know.
Is It Actually Possible To Make Money Trading Penny Stocks?
Penny stocks can go by many different names.
Some people call them ‘small caps,' and some people call them ‘micro caps.'
For the most part, the term ‘penny stock' refers to stock owned by a small company, that trades for less than $5 per share.
As you can see, the term ‘penny stock' can sometimes be a bit misleading!
In the past, penny stocks used to be labeled as ‘any stock that trades for less than $1 per share,' but of course, that definition has been modified by the U.S. Securities and Exchange Commission, or SEC.
(Definition: The SEC is, according to Investopedia, “An independent federal government agency responsible for protecting investors as they maintain fair and orderly functioning of the securities markets.”)
Some penny stocks are traded on large stock exchanges, such as the New York Stock Exchange. But for the most part, they are traded over the counter through a system called the OTC Bulletin Board.
The whole thing about penny stocks is this… they sell for much less than regular stocks.
Because they are used to help grow companies with limited cash and resources.
Therefore, they offer a low threshold for getting started with investing… but they also come with an increased level of risk.
The bad news is that they tend to lack liquidity… which essentially means that owners of the stocks may not always be able to find available buyers.
Plus, some penny stocks are just ‘sick dogs.' In other words, they are not very good companies, and they are destined to fail.
The good news? Since penny stocks can be purchased so cheaply, they can sometimes be resold for a much higher value, and can earn a lot of money if they are traded correctly.
This is why they also have a reputation for being a ‘high risk, high reward' investment.
How Do You Trade Penny Stocks?
Trading penny stocks is risky. Some of the companies involved are ‘fly by night,' and they tend not to have the longstanding reputation that companies traded on the major stock exchanges have.
Stocks that have dropped so low that they get ‘delisted' by the major stock exchanges can also end up on the OTC Boards.
You trade penny stocks through the OTC Board, or OTCBB.
The OTCBB is operated by Nasdaq, and is, according to Finra.org, “an interdealer quotation system that is used by subscribing FINRA members to reflect market making interest in OTCBB-eligible securities.”
In other words, the OTCBB is like a ‘marketplace' for penny stocks.
But there are actually two different platforms for over-the-counter securities.
The other platform is for private listing companies for over the counter securities. These are traded with ‘pink sheets.'
One of the first things you need to understand about penny stocks is that they are not always easy to trade.
They tend to have a mind of their own, and do not necessarily follow other market trends.
But… proponents of penny stocks also say that, if you do it right, they can be an important part of a ‘diversified trading portfolio.'
So let's quickly break down the steps involved in trading them.
Step 1… Learn About Stock Market Trends In-General
If you don't understand the stock market, you are going to be especially lost when you go to trade penny stocks.
In fact, many people recommend trading ‘mainstream' stocks first, before you try your hand at penny stocks.
With penny stocks, it is super important to understand the different types of trade patterns, how to spot them, when they tend to occur, what causes them, and how to respond to them before you start putting any money into it.
If you don't understand this, it will be very difficult to understand which penny stocks might actually be profitable.
Failing to understand basic market trends could very well end up with you ‘shooting in the dark' and taking risks with stocks that might not have a very high likelihood of paying off.
Step 2… Find A Penny Stock ‘Scanner' And Start Looking For Stocks That Fit Your Criteria
There are many different stock scanners out there. One great example is a tool called Finviz.com.
You start your search by setting up search parameters.
‘Beta' is the first term you will want to adjust. This is the measure of a stock's overall volatility in relation to the overall market.
Stocks rated at ‘1' on Beta are moving about as fast as the normal market stocks. Stocks under 1 are moving slower, and stocks over 1 are moving faster.
With penny stocks, you definitely want your volatility to be higher. So you will want to start anywhere over 1… possibly even choosing over 2 as a starting point.
You also want to set the stock screener to check for stocks that are valued at under $5, as this is where you will find all of your actual ‘penny stocks.'
Some people actually want to look for stocks that are cheaper than this, and select the under $1 option here instead.
Either way, fill in what you want and look for the stocks you are interested in.
You also want to set the ‘Average Volume Filter' to the appropriate number. You can start with the over 1 million option to start with… but this filtering criteria is important when you are looking for certain types of trends and patterns.
At this point, you can start scanning through the stocks to see what comes up.
Step 3… Figure Out What You Are Looking For
Again, this really goes without saying… you need to understand stock market trends before you ever want to spend money on penny stocks.
But, with that being said, most people who trade penny stocks are actually looking for stocks that check a few different boxes. You want stocks that…
- Are in a volatile sector
- Have taken a fairly recent massive hit
- Or, inversely, that have had a massive ‘green day'
Sometimes, stocks that have just had massive ‘red days' will also come back with massive ‘green days' after.
But at the end of the day, understand that most penny stocks eventually fail.
Because most of the stocks are just not from good companies.
This is where the high risk, high reward comes from.
But… if you can ride the waves, buy in, and sell out a the right times, you can make money with penny stocks.
Some people like to filter their results by the biggest recent losses and biggest gains. This can sometimes help you to isolate what you are looking for.
At any rate, you want to watch stocks, make a plan, find stocks to add to your watch list, and try to figure out which stocks can be bought into at a lower price, with some measure of reassurance that they will, indeed, rise again… allowing you to then sell them, making a profit on the trend.
Step 4… Identify The Best Opportunities, And Trade Those Stocks
It is important when trading penny stocks that you analyze the different opportunities, and then make a plan based on those stocks.
What you don't want to do is just start trading without making some kind of a plan.
You also don't want to waste time or money on stocks that are not offering you the best opportunities.
Another thing that you can do to check on companies before buying their stocks is to check their SEC filings. This can tell you a lot about a company, as they need to report their basic financial information this way.
Another benefit to checking out the company is to get their street address, and then Google it on Google Street View.
If you find out that their headquarters location is just a shack with an RV parked next to it, it is possible that this is actually not a reputable company… or, at the very least, that this is a company that is probably not going to make it big in the long run.
Penny Stocks Are Not An Easy, Fast Way To Generate Cash
A lot of people get lured into Penny Stocks because they hear that you can make huge profits with just a little bit of capital.
And yes, Penny Stock trading does offer some pretty interesting opportunities to catch trends, and you can sometimes make pretty good money when you catch moves at the right time.
But with that being said, it is also true that you need to educate yourself and learn everything you can to push the probability into your favor.
If you rely only on luck alone, you will doubtlessly lose money.
This is true on any kind of market.
If it was effortless and brainless to earn money trading penny stocks, everyone would be doing it… and everyone doing it would get rich off of it.
(Looking to trade regular stocks cheaply? Try out the Robin Hood app!)
Our Final Opinion Of Trading Penny Stocks
Should you try to trade penny stocks and make some extra money on them?
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