Last Updated: January 11, 2023
Inspired by successful stock market trading stories, many people want to learn how to buy penny stocks. Are you one of them?
If so, you first need to understand the nature of this investment, its potential risks, and gains. In addition, you should know where you can find penny stocks and what trading and screening tools you can use.
Here’s a brief rundown of the basics!
What Are Penny Stocks?
Penny stocks are shares of small private companies that are traded for less than $5 each. The name derives from the old system where penny stocks were those priced at $1 a share (the value of an individual stock was expressed in pennies).
The most significant difference between regular stocks and penny stocks is that with the latter, the majority of trade goes through over-the-counter exchanges (OTC). This, however, isn’t a rule, seeing as how some of the biggest penny stocks are traded on the New York Stock Exchange (NYSE), as well.
Why do people buy penny stocks?
First of all, penny stocks are less intimidating than their counterparts. People sometimes feel overwhelmed when it comes to buying shares of major companies and believe that penny stocks are more attainable.
Another reason why trading penny stocks is quite a good investment is that the volatility that comes with them can also become a positive thing. This means that you can multiply your gains far quicker than you would otherwise be able to.
Lastly, this volatile nature of penny stocks allows you to spread your portfolio thin and still achieve great results. Since the potential reward is great (and initial investment low, in most cases), you can be profitable even with a small percentage of successful trades.
To make it more effective, this would require going through lists of penny stocks and selecting ones that fit your investment goals and portfolio. If you do this right, you win big when you win, and you lose small when you lose.
This oversimplified explanation of how to trade penny stocks is also why so many new traders use day trading platforms to trade in penny stocks. Of course, there are some people who manage to make a fortune on penny stocks. But there also are many who just want to gain some stock-trading experience before transitioning into day trading regular stocks.
What are the average returns?
Now let’s delve a bit deeper into the average stock market returns.
According to the most recent statistics, the average stock market return is around 10%. Keep in mind, though, that these are the returns for long-term stock investments. When it comes to short-term ventures, the results are far more volatile and harder to predict.
What makes penny stocks so attractive is that their initial cost is so low that it’s relatively easy for them to achieve a stellar ROI.
How to Buy Penny Stocks
To learn how to successfully (and safely) buy penny stocks, there are several things you need to know.
Before you buy
If you’re a beginner who wants to buy penny stocks, you should first consider that these shares are pretty risky and volatile. So, make sure you only trade with the money you can afford to lose!
But are penny stocks safe?
Keep in mind that, just like with any other type of trade, there are many scammers here. Therefore, you need to manage your expectations and do your research before buying. Brokers who make promises of turning pennies into dollars in a matter of days are usually trying to scam you. While with penny stocks, such quick turnover is possible, the truth is that no one can safely make this promise, let alone guarantee it.
Research your target penny stocks
One of your go-to places for researching penny stocks to buy should be the U.S. Securities and Exchange Commission (SEC). There you can check a company’s stock listing status, financial health and fiscal reliability.
Find the right screener
Researching penny stocks is a lot easier to do when you have the right tool for the job. A specialized tool would allow you to search stocks based on the criteria that you set as filters.
For instance, a penny stock screener searches equities based on price, percent gain, volume, sector, or market cap. This makes your job a lot easier, and it doesn’t prevent you from doing your independent search of penny stocks, as well.
How to choose the right stock screener?
Most importantly, there are no screeners that specialize in penny stocks. Any stock screening tool will do.
The factors that you should look into are:
- Real-time trading info
- User-friendliness of the interface
- AI capacities
- Technical tools
- Customer reviews
Also, doing independent research on these screeners and reading some reviews is always a good idea.
As you can see, some of the above-listed factors are highly subjective, however. For instance, intermediate users may see technical tools as a top priority, while newcomers may put far more value into positive customer reviews and user-friendliness of the interface.
Where to Buy Penny Stocks?
To actually buy penny stocks, you need to find the right trading platform. The top-rated online stock brokers for beginners are your safest choice.
The main reason why Fidelity is at the top of this list is because it charges $0 for OTCBB (OTC Bulletin Board) trades. The platform also doesn’t have a minimum deposit, and stock trades are fee free. In addition, Fidelity’s mobile app is easy to use, and it provides a wide selection of great trading tools.
Another option for penny stock trading is Charles Schwab. This platform also has a $0 price for OTCBB trades and has a wide selection of penny stocks. Also, for stocks under $1, there are no additional fees. Most importantly, desktop users can research and select penny stocks through the Schwab StreetSmart Edge desktop platform.
The Interactive Brokers platform has a cost of $0.0035 per share, which is a bit on the expensive side. This can be especially problematic for penny stocks under 10 cents. However, IB’s advantage lies in the fact that it offers a larger selection of penny stocks than any other platform we’ve mentioned here. In other words, its advantages are rather situational.
Even though TD Ameritrade has a cost of $6.95 per OTCBB trade, this platform still has the widest selection of trading tools through its Thinkorswim platform.So while it’s more expensive than some of its counterparts, this platform may still be worth it.
Can You Get Rich Off Penny Stocks?
Getting rich off penny stocks is possible. However, the truth is that they are, on average, far riskier than their more expensive counterparts.
Here are several things you need to know about reducing risks and making money on penny stocks.
Top exchanges for penny stocks
When it comes to finding penny stocks, your safest bets are major exchanges such as Nasdaq and NYSE. Keep in mind that there, you can only find those penny stocks that can pass the listing requirements. In other words, while no penny stocks are ever 100% safe, these tend to be a bit more reliable.
How to know what penny stocks to buy?
The short answer is – you can’t. However, there are several tips and tricks that can make your decision-making more consistent.
First, you should look for stocks that are already spiking. There’s a higher likelihood that a growing trend will continue for a while than for a sudden shift in a falling stock value to occur.
Second, betting on price action is known to give results in a lot of scenarios.
Third, do your research and don’t always believe in public hype. We’ll discuss the dangers of this once we get to the stock manipulation and stock market scams.
What to look for in Penny Stocks?
When it comes to finding penny stocks that are worth investing in, there are three major factors you should look into:
- Company’s track record
- Past performance of the stock
- Industry type
These three factors will determine the risk level and indicate whether the company whose stocks you are interested in has systemic problems. Buying off the penny stock list without doing your research is really no different than gambling.
Can You Lose Money on Penny Stocks?
If we had to use one word to describe penny stocks, we would have to go with – volatile. This means that in the case of a short squeeze, you could lose 50% or more quite easily. This is especially true for low-quality stocks, seeing as how they’re cheap and potentially highly profitable.
Try paper trading first
While finding penny stocks to invest in can be quite inexpensive, it’s probably a better idea to get some practice first. Some platforms offer paper trading options. This stock market simulator allows you to reproduce or duplicate some trading options in a safe environment.
This benefits you for a couple of reasons. First, it provides you with an opportunity to get familiar with the mechanics. Second, it gives you an idea of how much money you would gain/lose with your current trading skills and choices.
Watch out for stock dilution
While learning how to trade penny stocks, you also need to get familiar with some of the biggest potential risks. One of them is the so-called stock dilution.
When a company issues new equity, it actively decreases the ownership percentage of the existing shareholders. To put it simply, if you own 5 out of the total 10 shares, you own 50% of the company. If the total number of shares jumps to 20, with those same 5 shares, you will own only 25% of the company. With penny stocks, this is far more likely to happen than with publicly traded companies.
The gold rush approach
Besides learning how to buy penny stocks, you also need to know how to govern your own expectations, emotions, and responses.
The thrill of a significant win (even someone else’s) can make you too ecstatic and affect your decision-making, thus making you more likely to engage in risky stock market behavior. More often than not, this results in a major net loss. After all, this is not gambling, and there’s no such thing as a lucky streak.
Stock Trading Scams to Watch Out for
Investing in penny stocks is quite volatile. Yet, the most significant risks stem from scams. So keep your eyes open for the following:
Parties with a lot of purchasing power or reputation within the industry often can manipulate the value of the stock to their own benefit. The problem with this is multi-fold.
Most importantly, beginner traders are never “in” on the secret. This means that while they’re learning the rules, someone else is rigging the game.
The best you can do when day trading penny stocks is to do your research. Yet, with stock manipulation the value of the stock will grow/drop regardless of the real performance of the company in question. So, as a piece of advice, if something sounds too good to be true, it usually isn’t.
Pump and dump
Pump and dump occurs when a malicious group or individual boosts the stock price by sharing fake positive information. For a small stock of a company whose value is not that high, this could result in a disproportionate amount of stock value gain, literally overnight.
Poop and scoop
This technique is virtually the opposite of the above-listed pump and dump. Namely, the malicious party starts spreading rumors regarding a large-cap company to lower the value of its stocks so that they can buy them. While this method is not as popular for penny trading, it’s a way of stock manipulation that a penny trader needs to get familiar with.
If someone uses information that’s not yet available to the public in order to make a profit on the stock market, this is considered insider trading. By far, this is the most notorious and fraudulent form of market manipulation.
This illegal scheme usually involves the best trading stocks. But it’s not uncommon for insider trading to happen in smaller companies, as well.
It’s pretty easy to understand why people trade penny stocks. They’re inexpensive and hold a high-yield potential. Yet, this type of investment is quite risky.
Therefore, It’s not enough to learn how to buy penny stocks. To increase the success rate of your trades, you should do thorough research, get some practice, and really understand what you’re getting into. Most importantly, you need the right tools and platforms for the job. This way, your odds will drastically increase.