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Beginner’s Guide to Trading in Penny Stocks

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Regardless of whether you are an active investor or not, you must have heard of penny stocks. It’s a popular concept in movies, where an unscrupulous trader reaches to riches by selling crappy, low-value stocks to people. Yes! The movie we are talking about is Wolf of Wall Street, but that’s just one. Movies have never been kinder on penny stocks. They have always highlighted the negative aspect of penny stock.

There is no denying, penny stocks come with a certain risk, but don’t most investments. With the right strategy, you can make a lot of money trading in penny stocks. Penny stock has the capability of turning small capital into a high turnover investment. But, it’s tricky, the reason most people involved in trading penny stock walk with loss. However, the good news, we can help you make a profitable investment in penny stocks.

Most people invest in over-the-counter (OTC) markets, and that’s the reason they end up with a loss. You should trade in stocks listed on highly regulated exchanges, where companies are more promising. The reason these companies are trading low is that the companies are new and it’s only a matter of time before the pennies per share turn into dollars per share. Identifying companies with potential in the future is how you should trade in penny stocks.

What are Penny Stocks?

Before we start with more serious stuff, let’s go over the basics. What are Penny Stocks? The name is suggestive of the nature of the stock. Any stock that trades for less than a dollar is called a penny stock. But, this definition varies. As per the Securities Exchange Commission (SEC), stocks trading under $5 per share is termed as a penny stock. These stocks are speculative in nature.

Companies that offer penny stocks are new or upcoming with low market capitalization and a good business model and track record, which makes their stock speculative. The stocks could pay big if the company is successful or you could lose all your money.

Penny stocks have attracted all types of investors due to the low investment required, particularly new investors. However, penny stocks are highly volatile and you could easily end up losing all you have earned.

What sets apart a loser and a winner while trading in penny stocks is the educated decision making. Rather than treating penny stocks as a lottery, you should make prudent decisions. That’s why it necessary that you learn about trading in penny stocks. Read further to get started in Penny Stocks like a pro.

Getting Started with Penny Stocks – Choosing Exchange

There are two places you could trade in penny stocks – OTC exchange and through stock exchanges like NASDAQ or NYSE. As a general rule, avoid OTC trading. Established stock exchanges have strict guidelines that companies must adhere to in order to be listed. These rules include complete financial transparency and maintaining the stock over $1 per share. The companies that fail this criteria list their stock in OTC.

These companies are shady without clear financial documentation or maybe in bankruptcy filings, the reason they choose OTC. Trading in over the counter market is a risky investment and the reason why most people lose money in penny stocks.

Listed penny stocks on the other hand are companies that have a future, a structure of operation, a linkable reputation of successful businesses, and are generally companies you would expect to be successful in the long-run. These are companies you would want to invest in.

Test your Strategy with Paper Trading

You know the stock exchange where you should be trading, but you are not yet ready to trade with your hard-earned money. Profitable trading requires practice and strategy. The best strategies are the ones you learn through trial and error. Fortunately, paper trading allows you to trade without betting any real money. This method utilized real-time reporting on the price of stocks to trade with fake money. Several websites allow you to paper trade for free or for a subscription fee of the website.

As you start trading, you are bound to make mistakes. With paper trading, you don’t pay for those mistakes with your hard-earned money. As you try out successful trades over and over again, you will become confident about your strategy. At this point, you can try trading with a small amount of real money using the same strategy you learned with paper trading.

How To Find the Best Penny Stocks

The trick to becoming a successful investor in penny stocks is identifying the stocks that have the best probability of a strong run. But how do you identify those stocks? Don’t invest in stocks that you have heard about from a friend or from someone else. Hordes of people are already buying those stocks, overpricing the buy price of the stock. The value of overpriced stocks gets matured and they fall very fast. If you opt to buy those stocks,  you may end up on the losing side.

Instead, buy stocks of companies that you are familiar with. Suppose you are into video games, it’s more likely that you will know about the new companies in the niche and how their future will pan out based on the game they are developing. In such a scenario, you are in a better position than most people in the market. The trick to successful investment in penny stocks is to move away from the herd mentality. Most people lose money in penny stocks because they buy what everyone is buying and end up investing in overpriced stocks. Rather, you should be doing the opposite, stay from penny stocks that have gained much attention.

Let’s take another example. Suppose you are a pharmacist by profession, you would know about the new companies that are entering the biotech space that other normal people may not know about. These are the stocks you would want to bet your money on.

While selecting penny stocks, you can have certain parameters to filer the stock that will assure the company you are investing in has a long run. The first parameter you need to watch out for is a recent discovery, an FDA approval, acquisitions, or any piece of news that would provide a company an advantage in the coming days and years. This is the catalyst that would fuel the surge of the stock and the value of the company. To become a successful investor in penny stocks, you need to stay on top of news and identify such opportunities. However, do not invest in stocks that have a history of not treading far from the purchase price.

The second parameter to observe is the share should have a restricted float i.e. less than 100 million shares or less than 50 million would be even better. When there is a limited amount of shares trading in the market, the demand-supply rule applies. It creates a sort of scarcity mentality and people tend to buy more. As people buy more, it gaps up the price of the share and that’s exactly what we want. But, don’t get greedy when you have made about a 20 – 30 % profit. Sell the share and move on. Most people end up in loss after making a profit and holding the penny stocks.

Identify stocks with demands in the premarket, this means the stock will have a lot of activity when the market opens. These are stocks you would want to target as a lot of buying and selling is going to happen on those stocks.

Still Unsure About the Company or Industry?

Selecting stocks in penny stock trading is the most difficult task. So, if you are still unsure about the company or industry you want to invest in, then, it’s best you stick to what you know. Your passion is where you should start. Sometimes your profession might not be the best fit simply because after spending a long day working your job, you don’t want to be reading and researching the same thing again. A welcome refreshment can be your hobby. It could be fishing, fashion, sports, eating, or a range of other things. You should look out for companies in the field. You have an advantage over other investors because you are personally invested in the sector and would naturally know more than a normal investor.

Final Thoughts On Penny Stock Trading

Trading in penny stocks is not for the weak-hearted. Penny stocks are one of the most volatile instruments of investment that can garner high gains or a big loss. However, being strategic about your investment rather than treating penny stocks as lotteries can make you hundreds of thousands of dollars from a mere $1000 investment. Read through our guide and apply the tips we have shared for a profitable investment in penny stocks.

Tip: Don’t invest large sums of money in penny stock unless you are confident in your strategy and have tested it for a prolonged period.           

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