Investing in Penny Stocks
How to invest in penny stocks? Penny stocks trading appeals to both beginner investors and to more seasoned investors. For those new to investing, the allure of buying a stock trading for $0.20 and hoping it will triple is huge. At the same time, experienced investors with a high risk tolerance also love penny stocks for the same reason: massive growth potential.
Whether you’re new to investing in penny stocks or have been trading penny stocks for years, if you don’t know how to trade penny stocks, you could end up broke. After all, penny stock trading seems pretty simple. How hard can it be for a stock to double from $0.25 to $0.50, or $1.00 to $2.00?
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Pretty hard actually. For a stock to legitimately double in price, it needs to announce something pretty spectacular. After all, it’s not just that the stock price is doubling, this also implies the company is now worth twice as much. That’s not an easy task.
That said, the chances of an under-the-radar penny stock doubling or tripling in price is definitely greater than seeing a $100.00 stock go to $200.00 overnight. That’s because most companies that trade as penny stocks have small market caps with little revenue. So announcing a new client or two could certainly help boost the company’s bottom line.
As experienced penny stock investors know though, without something to propel the price of a penny stock higher, it will just languish and could die a long slow death. Which can be difficult to watch. Especially if it has low daily volume. It can be easy to get in but almost impossible to get out of.
At the same time, for beginner investors, it can be easy to take a big stake in a penny stock. With just $500.00, you can buy 2,500 shares of a penny stock trading at $0.25. The gain of just a few cents can really translate into solid returns.
But that’s the joy and excitement of investing in penny stocks. There is a risk/reward trade off. Riskier stocks come with the potential for greater rewards and an increased chance to lose your entire investment.
Despite this, penny stocks still get an undeserved bad rap. Wall Street will tell you that you should avoid penny stocks at all costs. The risk outweighs any benefits. Even the U.S. Securities and Exchange Commission (SEC) warns “investors in penny stocks should be prepared for the possibility that they may lose their whole investment.” (Source: “Penny Stock Rules,” U.S. Securities and Exchange Commission, May 9, 2013.)
Sure, but the same could be said for investing, period. A lot of people have lost a lot of money trading in penny stocks. Just like investors have lost money trading on so-called safer stocks.
Just ask those who invested in rock-solid companies like Enron Corp., Pacific Gas & Electric Co., and Lehman Brothers Holding, Inc. Or investors who jumped the dot-com bandwagon and lost big on Pets.com, eToys.com, and WebVan. If you don’t know what you’re investing in and don’t know what to look for, it doesn’t matter if you’re investing in a penny stock, mid-cap, or large-cap stock, you can lose everything. It would just be unfortunate for an investor to lose out on massive gains simply because a stock is a penny stock.
What Exactly Is a Penny Stock?
Where a penny stock was once described as a stock trading for under a dollar, today, thanks to inflation, the term is not so easy to pin down. A penny stock can be defined more broadly as a stock trading for under $5.00. Some even call equities trading for under $10.00 a penny stock.
Regardless of the cut-off level, once the phrase “penny stock” is attached to a stock, investors tend to turn their back on it. This is unfortunate for many reasons. First, there are a lot of excellent small penny stocks with compelling stories and great short- and long-term growth potential. Second, there are a lot of so-called penny stocks out there trading under $5.00 and $10.00 with market caps over $5.0 billion.
Why do investors and Wall Street largely avoid penny stocks? Wall Street doesn’t like penny stocks because they’re too small to take a large position. If they can’t make money on it, they don’t want it. Retail investors turn their nose up at penny stocks because, for the most part, they can be difficult to research, and it’s easier to follow the herd than invest in something on your own.
But investing in stocks you don’t understand can be just as risky as investing in a penny stock you don’t understand. And as Warren Buffett has said, “Never invest in a business you cannot understand.”
During the dot-com era, quantitative easing years, and Trump Bump, investors didn’t pay attention to stocks and their underlying valuations. They bought on news and sold on dips; they ignored fundamentals and focused on momentum and technicals. This kind of investing strategy never ends well.
What Should You Look for in a Penny Stock?
Keep in mind, 98% of penny stocks are indeed garbage and should be avoided at any cost. How do you separate the wheat from the chaff? To succeed as a penny stock investor you need to conduct thorough due diligence. It’s the only way to find the best penny stocks to invest in. This goes for both short-term and buy-and-hold investors. After all, the joy of penny stocks is that they can make meteoric gains in a short period of time.
While a technical and fundamental analysis are the two best ways of weighing the pros and cons of a stock, this isn’t always the case with penny stocks.
Day traders love technical analysis, studying daily trends and buying on momentum. It’s difficult to do this with penny stocks. Penny stocks can be thinly traded and volatile. The same kind of technical indicators that would suggest an entry and exit level for a mid- or large-cap stock is probably going to be useless with penny stocks.
That said, you still want to make sure the penny stock is not thinly traded. A thinly traded stock is easy to manipulate. It’s also easy to buy but difficult to sell.
With penny stocks, the best way to predict a trend is to conduct a thorough fundamental analysis. This includes looking at a company’s financial statements and taking note of quarterly results, revenue, earnings, cash flow, and debt flow.
Does the penny stock provide a dividend? Does it have a share buyback program? What is the management team like? Do they provide a long-term outlook? Speaking of management, because it’s a penny stock (and probably small) you can most likely call the company and speak to the CEO directly. You can’t do that with Apple Inc. (NASDAQ:AAPL) or Tesla Inc (NASDAQ:TSLA).
Some fundamentals will be more important than others. You might not care if a penny stock provides a dividend. But if it has $500.0 million in debt, reported no revenue in the last quarter, has a loss of $50.0 million, and a bleak outlook, you might want to take a step back. No matter how ground breaking and earth shattering their technology is.
The more you understand a penny stock, the more confidence you’ll have in it and the greater your chances of finding a good entry and exit point.
How to Invest in Penny Stocks for Beginners
Seasoned investors who are not afraid of risk understand that when it comes to penny stocks, like it does with any equity, you only invest what you’re willing to lose. This is a tough strategy to follow for penny stock investors just starting out.
Judging by the number of people who invest in seemingly worthless penny stocks, it’s something that needs to be at the forefront; because, again, very few penny stocks are worth investing in.
Some will say it’s difficult to find profitable penny stocks with solid operations, strong fundamentals, and great momentum. And it is, if you don’t do any research. If you’re new to penny stock investing, do your research. It’s good experience and will help down the road when you start investing in other kinds of companies.
Once you have found a penny stock to invest in, decide what your thresholds are. How much are you willing to lose and how much profit do you want to take home? Penny stocks are known for their massive returns and some penny stock investors hold out for gigantic gains no matter what! And that could be a mistake.
Penny stocks are attached to businesses just like every other stock. And the stock is only as strong as the underlying company. Even a solid, well-run penny stock can experience daily gains or losses of five percent or more. It can move on earnings, rumor, and even investor sentiment.
Set a profit goal and stick to it. A 50% or 100% gain is excellent. Don’t get greedy. A penny stock can plummet as quickly as it soared. Keep a close eye on it and take profits or leave some on the table if you think the penny stock still has legs. At the same time, don’t fall in love with a penny stock. Stay objective and watch it daily. Take profits or losses if need be. But don’t get complacent. It’s better to take a loss and put that money to better use elsewhere.
Where Do You Find the Best Penny Stocks?
How do you find penny stocks? First and foremost, don’t let them find you. Ignore any and all unsolicited emails that tout the next big thing. It’s a paid marketing ploy designed to get you to part with your hard-earned money.
If you had a hot penny stock tip, would you really share it with the world? No. You’d keep it to yourself and make a lot of money. So why would someone send you an unsolicited hot tip? There’s always a catch. In these cases, it’s you.
If you’re looking for legitimate penny stocks to invest in, there are a number of great exchanges you can turn to. In the U.S., you can find excellent penny stocks on the New York Stock Exchange (NYSE) and NASDAQ.
You can also find solid penny stocks on the Over-the-Counter Bulletin Board (OTCBB). The OTC is not an exchange like the NASDAQ or NYSE, it’s a decentralized quote system made up of market makers connected by computers or phones. This market is for securities that are not listed on major stock exchanges.
While stocks listed on the OTCBB need to comply with SEC requirements, other OTC stocks do not. Equities listed on the Pink Sheets have no reporting requirements. It’s the Wild West of stocks. And it’s best to stay away. Frankly, any OTC investing, even the OTCBB, is best left for experienced investors.
If you want to look beyond the U.S., you can find excellent penny stocks trading on the Toronto Stock Exchange (TMX TSX). Roughly 60% of all the world’s publicly traded mining companies are listed on the TSX. You can also find great penny stocks on the London Stock Exchange (LSE) and the Australian Stock Market (ASX). (Source: “Mining,” Toronto Stock Exchange, last accessed April 10, 2017.)
Penny stock trading can be an exciting part of investing. But it’s important to understand how to invest in penny stocks, the different ways to trade penny stocks, and where to find the best penny stocks. Wall Street might avoid penny stocks, but for retail investors, when meticulously researched, well-run penny stocks are an excellent way to juice your retirement portfolio.
