How To Invest In Penny Stocks

Penny stocks are risky business.  It is one of the riskier places that traders and investors may engage within the entire stock market.  If you want to know how to invest in penny stocks be sure you have a pile of cash ready that you don’t really care if it goes poof into oblivion.

Penny Stock Definition

A stock that trades at a relatively low price and market capitalization, usually outside of the major market exchanges. These types of stocks are generally considered to be highly speculative and high risk because of their lack of liquidity, large bid-ask spreads, small capitalization and limited following and disclosure.

In this introduction of ‘How To Invest in Penny Stocks” we will cover the following topics:

  1. What Is A Penny Stock
  2. How To Invest in Penny Stocks
  3. How To Invest in Benny Stocks for Beginners
  4. How To Invest in Penny Stocks Without a Broker
  5. How do I find penny stocks to invest in
  6. How to invest in penny stocks and make money

What Is A Penny Stock

Most Wall Street experts define penny stocks as those stocks with a share price under $1 per share.  However, recently the SEC has revised the definition of a penny stock to stocks trading at prices at or below $5/share.  Most new investors like to invest in stocks with a lower share price, however this typically comes with greater volatility and risk.  That being said, if you really want to get involved in this type of trading read on.

Why are they called penny stocks if they are trading for more than $1/share?

While the share price of a penny stock may actually be above the $1/share mark, the SEC still views all stocks trading under $5/share as extremely risky and volatile.  Penny stocks are typically stocks of growing companies that have limited cash and resources.  The lack of cash and other resources make them very risky as it increases the likelihood of the business failing or becoming much less valuable in the near future.  Penny stocks also typically have lower trading volumes which makes it easier to lose money and sell your shares at an attractive price.

How To Invest In Penny Stocks

Below is a basic guide of the steps which will answer your question of how to invest in penny stocks.  This is a comprehensive guide on how to invest in penny stocks that starts at the beginning where you’re just thinking about getting into penny stocks all the way through opening your brokerage account and making your first purchase.

Step 1:  Understand What it Means To Trade Penny Stocks

And yes, we said “trade” on purpose as most people looking to get into penny stocks are going to be traders looking to make a quick profit.  Most people who get into penny stocks do not plan on holding the stock for many years hoping for their investment to skyrocket.

Do your research!  It may be harder to research penny stocks because of the following factors:

  • Very little information available.  Not all penny stocks are traded on the stock exchanges.  Due to this fact these companies do not have to file with the SEC which means they aren’t as researched.  The prices could be really far off from the actual value of the company.  The company could have shady accounting practices or on the verge of bankruptcy.  It’s hard to place a big bet without much information.  Do your best to research these stocks.
  • No Minimum Standards to remain on OTCBB exchage. Since there are no real minimum standards to remain on the OTCBB exchange, this means not much of a safety cushion for you.
  • Low Levels of Liquidity –  It sometimes proves difficult to find a buyer for your penny stocks meaning your assets could be tied up in the stock until you find a buyer.

Step 2:  Open a Brokerage Account

The next step in trading penny stocks is to open a brokerage account.  Some of the popular online brokerages like TdAmeritrade and eTrade are good to begin with, however, some don’t let you trade penny stocks with the basic account.  You’ll need to research and find the broker that works with the types of stocks you really want to trade.

Step 3:  Do Your Homework on Your Penny Stocks

Penny stocks will typically have a lower share price related to specific situations.  You need to look for certain news events or market conditions that could negatively affect the stock you want to purchase.

  • Ensure your penny stocks are traded over an actual exchange and not “over-the-counter”.  OTC stocks carry greater risk as they don’t pass through the same regulatory process.
  • Avoid signs of decay or companies drifting closer to bankruptcy.  It may seem like a good deal but no one gets a free lunch on Wall Street!

Step 4:  Don’t Believe Hyped-Up Stocks

Remember, penny stocks are traded on low volume and just a few pennies can mean big gains for traders.  That being said, when a penny stock is hyped up you have to be careful and determine if it is really a good investment or if someone is just trying to pump up the price so they can dump it by attracting more buyers.  With low share prices and low trading volumes, it only takes a few buyers to have a dramatic affect on the price.

Step 5:  Choose A Strategy and Look for Volume

When trading penny stocks you need to have a solid strategy in mind and stick to it.  Whether you have a sell quick strategy or a buy and hold you need to know what each trade is and stick to it.

Also, when beginning penny stock trading you should look for stocks that have at least a average daily volume of 100,000 shares traded daily.  This will provide a little bit of safety int he form of liquidity – meaning you can get your money out if you want.

If you are trading more than 10% of the stock’s daily volume that is too much.

One way to keep a relatively safe investment is to ensure you remain liquid.  If you are trading more than 10% of the stocks daily volume, it is difficult to dump that much stock if you need to.

Make Your First Trade

Now that we’ve laid the ground rules, it is time to execute your first trade.  Find the stock you like, choose your entry point based on your research and pull the trigger.

How To Invest In Penny Stocks For Beginners

Traders that are brand new to the stock market should not really be investing in penny stocks.  So when we title this section “how to invest in penny stocks for beginners” we really mean seasoned traders that are looking to get into buying and selling penny stocks.

The rules are pretty much the same as outlined above.  However, we’ll take this one step further and recommend that if you want to get into penny stocks, you begin paper trading.  This means don’t use real money just yet.

If you’re worried you’ll miss hitting the big one while paper trading, you’re not quite ready to begin trading penny stocks as that sort of thinking is what can set you up for failure.

Once you have paper traded for a few months and you are comfortable with your penny stock trading strategy you can dive-in with some real dough.

How To Invest In Penny Stocks Without a Broker

You do not need an actual real-life broker to invest in penny stocks.  There are several online brokers that will be more than happy to broker your transaction into the risky world of penny stocks.

Online brokers like TD Ameritrade or E-Trade work well for trading penny stocks and when you open an account and make a deposit they will typically give you 50 to 100 free trades (look for their promotions).  TD Ameritrade and E-Trade also offer real-time trading platforms that are great for trading penny stocks online as they let you watch the real-time trading action and plan your buys and sells accordingly.

Know that trading penny stocks is not like trading traditional stocks.  You need to understand how over-the-counter stock trading works.  These types of stocks are traded over dealer networks as opposed to a standard exchange.

Typically stocks are traded OTC because they are a small company and not able to make the requirements to be listed on the big stock exchanges.  These OTC buys are handled by broker-dealers who negotiate with one another over computers or phone.  Due to this fact, we can see why the volatility is higher, the bid/ask spreads are wider and there is more risk involved in penny stocks.

Once you’re ready to pull the trigger, you can initiate your “buy” order via the online broker.

How To Invest In Penny Stocks Online

Investing in penny stocks online is pretty much the same as investing in penny stocks without a broker.  You’d need to setup an online brokerage account with TD Ameritrade, E-Trade or TradeKing, do your research and begin trading.

How do i find penny stocks to invest in?

Finding penny stocks in which to put your money is the most difficult part of penny stock investing for an individual.  You need to do diligent research and can not trust every website or advertisement you come across.

How do i find penny stocks to invest in – Penny Stock Websites

There are many different penny stock websites that will help you find penny stocks to invest in.  While you can not take their work on every stock they recommend, it definitely will help you build a list of companies that you can research.

All you really need to do is perform a Google search on “How do i find penny stocks to invest in” and start clicking on a few of the results and sponsored links.  Jot down some of the tickers and begin your investigation on these companies.

How to invest in penny stocks and make money

There is no magic formula for investing in penny stocks and make money – the best advice is to do your research.  You need to be confident in your stock buy and have a level of conviction with your buy order.

If you want to invest in penny stocks and make money you should be able to answer the question “Why Is Your Penny Stock Going To Go Higher”.  You should be able to provide a sound answer to this question that ties back to the business and why you think their company is going to grow and make more money.  If your answer is because it’s “HOT” right now, you’re gambling and not performing educated research and investing.

The Risk of investing in penny stocks

Most small cap stocks are new start-ups and historically most of these business end up closing their doors within a year!  There are also many penny stock scams that you need to keep your eye on.

The fact of the matter is that even legitimate penny stock companies still carry very high risk due to lack of liquidity and poor reporting standards.  The lack of reporting standards opens the door for dishonest people to come in and run a muck with your cash!

Due to the risk of penny stock investing, your brokers are even required to send you a document outlining the risk of penny stock ownership to ensure you, the American public, are not investing in something you know nothing about.

Why Do I get All of This Penny Stock Spam?

Spam is annoying and not only wastes our time, but fills up our email servers.  If you’ve ever skimmed through your spam, you’ve probably seen emails for penny stock investing.

Along with email, you may have also seen the same sort of penny stock spam content in message boards, chat rooms and even websites or ads on Google.  The point of the spam is to get uneducated people to roll the dice and invest in a penny stock with the hopes of getting rich – but without doing any research.

The penny stock spam is the modern-era version of the pump and dump.  These companies or individuals sending out the spam already have a stake in the company and they want to sell you their shares for a profit!

Think about, it only costs a few bucks to put up a penny stock website and sending email is virtually free – this is cheap marketing and makes the spammers a huge profit.

The main point of this is to not purchase penny stocks that you see in an email 🙂