You’ve probably heard of Penny Stocks, by chance or via the movie “The Wolf of Wallstreet”. In either case, you may not have all the details in place to understand or know what Penny Stocks actually are or how to trade them.
What is a Penny Stock?
To know if you want to trade Penny Stocks, you need to know what they are. The name does sort of give the asset away; Penny Stock is stock trading for $5 or below. These are stocks that for whatever reason are quite low priced. They can be either a bust or offer a great profit and given their low price, it is well worth the shot for those who are into day trading or who enjoy to have a certain part of their portfolio focused on riskier bets with higher returns (as risk is rewarded with higher returns).
Which Penny Stocks to Choose?
Some stocks have low prices for a reason. You need to pick stocks that are not duds from the start, and to do so you should check the following:
Why is the price low?
Is it due to a scandal that is irrelevant for the survival and growth of the company? Or is the price low as a consequence of other factors pointing to the company stagnating or even degrading? Research is your best friend, and the more time you can put on this part the better the chances for you to actually make something of those invested pennies. As with regular stock trading, do your due diligence and choose ratios or information to trade with that suit your way of trading when choosing the Penny Stocks to invest in. Use tools available to you for free, such as Yahoo Finance to check company data.
Check the financials.
When choosing which stock to put your money in, choose one that has solid earnings growth. As mentioned in the point above, the price may be low due to a temporary issue facing the firm that due to media coverage and investor fear may seem unsurmountable, but the earnings show a company in good condition. How is the company fairing in terms of other financials, such as debt and solidity?
May or may not be a problem but if you buy a Penny Stock and see its price finally rising, it would be a sad end to the story if you can’t sell it in time because there is no volume in this stock; low volume means there is practically no one trading the stock, so when you choose to sell the stock it is not certain there is an interested buyer at that exact time or in a future near enough for the trade to be interesting.
How much are you willing to loose of your money invested in one particular trade? This is an important question, as it is a bet you are making to hit it big, and most trades on your way to that one big-return-trade will be losses. You need to have the mentality to trade these stocks, and know yourself well – you need to know what your limit is.
How much do you put in one single trade?
Penny Stocks are a complement to your portfolio, and as a complement should not constitute a large part of your portfolio. Having 5-10% of your total portfolio on risky assets and possibly high yielding asset such as Penny Stocks is a good rule of thumb.
You need to have a plan for how long you are willing to hold your Penny Stocks. When is enough in terms for waiting for a piece of good news that will push the price up? Penny Stock trading is usually seen as a short term investment, something you should keep in mind when setting your trading horizon.
At this point you have a Penny Stock trading strategy. You have an entry and exit signal, you know how much you wish to invest in one single trade and how much of your portfolio Penny Stocks will constitute, you have set a stop-loss and are ready to go.
First, we need to go through some use of terminology before you get confused by what follows: most large companies that you might have traded previously such as Apple are listed companies. Listed means that a company has gone through various processes and regularly submits certain reports to regulators and the exchange where it is listed.
An exchange then is a place for companies that meet certain requirements and are perceived to be less risky due to the reporting requirement put upon them. Companies that wish to be traded but do not meet the requirements set on listed firms or if it has been kicked out of an exchange due to missing to meet requirements end up as over-the-counter stocks (OTC), and are traded in other marketplaces then exchanges. A trade done over-the-counter is between individuals, done via phone or more likely via an internet transaction.
Penny Stocks, due to their low prices and status as low-grade stocks do not trade on the regular stock exchanges you may be used to in your regular trading. These stocks will be found in secondary markets, and which one is relevant for you and available in your country will vary. In the US, Penny Stocks will be found via Pink Sheets marketplaces and traded over-the-counter by brokers. Pink Sheets used to daily publications that show the ask and bid price of stocks for unlisted firms, firms that do not trade on an exchange. These days such information is available online with ask and bid quotes being updated in real time.
As with other stocks, you can trade Penny Stocks via a broker which makes the choice of a serious and reliable one quite important.
Some Penny Stocks do trade in regular stock exchanges, making it easier to trade them of course. Choose the exchange or other marketplace and brokers that meat your preferred way of trading.