A Crash Course In Penny Stock Basics
If you’re looking for ways to make money in the stock market, penny stocks may be something that comes to mind first. They’re cheap, they’re known for providing handsome returns, and all the Apes seem to love them. A classic example of why penny stocks attract so much attention is AMC Entertainment (NYSE: AMC). This was just a $2 stock at the beginning of 2021.
But a mix of unique market metrics had all of the stars align, which resulted in the event that likely changed the make-up of the stock market as we know it. Shares of AMC stock ultimately went on to explode to highs of $72.62.
How can you say penny stocks are bad when this one stock alone ran over 3,500% in just a few months? The answer is that you can’t, but it’s essential to know how to trade penny stocks so that you make money consistently and not strike out because you wanted a home run each time.
What Is A Penny Stock?
A penny stock, in general, is the stock of a small company that trades for less than $5 per share. It’s important to remember that we’re referencing the price alone based on this definition of a penny stock.
Popular opinion suggests that all penny stocks are traded on the Over-The-Counter exchange or “OTC” exchange. That is a misnomer that many new traders tend to assume. Not only do penny stocks trade on the OTC, but there are also plenty of small companies traded on the NASDAQ and New York Stock Exchange (NYSE).
Risks Of Trading Penny Stocks
Penny stocks like AMC are unique, and not all cheap stocks go on to explode thousands of percentage points. Hopefully, that’s obvious enough that you’re questioning why I even made that statement. There are many risks involved in penny stocks, and new traders should know them before diving in head-first.
Liquidity is the total trading volume in a stock. When we’re talking about penny stocks, focus on dollar volume instead of the number of shares traded. Since the cheapest penny stocks trade for as little as $0.0001, share volume alone can cloud your judgment. Case in point, 100 million shares of a $0.0001 stock is only $10,000. Now, I’m not suggesting $10,000 isn’t a lot of money. But when you’re talking about the bigger picture, a stock that only trades a few thousand dollars in volume isn’t very liquid.
Penny stocks, in general, have lower liquidity daily compared to most large-cap stocks like Apple (NASDAQ: AAPL) or Microsoft (NASDAQ: MSFT). I say “consistent” because, along your travels, you’ll likely come across certain penny stocks that will see hundreds of millions of dollars trade in a single day. The vast majority of companies that experience such activity usually cool off in a big way during days or weeks to follow. One recent example is Avenue Therapeutics (NASDAQ: ATXI).
Late in November, the company announced FDA-related news. Shares skyrocketed 60% overnight, and ATXI stock traded millions of dollars in liquidity. Fast-forward a few weeks, and ATXI stock is roughly 50% off its November 29 high, trading less than $100,000 a day at times. If you were a day trader and taken advantage of that single day of action, the chances of making money were much higher than buying and holding with the expectation that the unusually bullish trend would continue. So when it comes to liquidity, you’ll want to research market activity just as much as corporate developments.
Penny Stock Prices Fluctuate
Liquidity can go hand-in-hand with another risk for penny stocks: price fluctuation. Companies that fit this price criterion are typically early or development stage companies. As such, speculation can play a role, which may also get reflected in market activity. Let’s use the ATXI stock example. Traders speculated that the FDA event in November was a big one for Avenue Therapeutics.
While that may or may not prove to be the case in the future, traders rapidly bought up shares at the time of the update, which ultimately saw Avenue’s market cap increase 50% in a single day. Was the company worth 50% more because of that news? As time went on, we could see that the market, overall, didn’t seem to believe in that valuation for the longer term.
But this speculative trading volatility isn’t unique to ATXI. It’s almost a daily event when it comes to penny stocks. Most of the time, the big move isn’t followed by an even bigger one during the following sessions. Again, this isn’t always the case; however, as a rule of thumb, if you’re looking for penny stocks to buy, a shorter time horizon for taking initial profit is better, especially for new traders.
For readers who are more advanced and know a bit more about finding penny stocks with long-term potential, this article isn’t for you.
Price Fluctuations Aren’t Only Based On Large Swings In Dollar Value
Regarding price fluctuation, I also want to mention that it isn’t only about how quickly a stock moves a certain amount of “dollars,” per se. You’ve also got to keep in mind the price of the stock, in general. If you’re buying a $0.50 penny stock, it doesn’t need to move several dollars to experience a significant percentage change.
Volatility comes in other forms. In this example, the 50 cent stock only needs to move 5-10 cents, and you’re talking about a 10 or 20% move in value. That is much more volatile than the $5 penny stock that moves the same amount. So another rule of thumb: the cheaper the stock, the more the price plays a role in percentage change for your position.
How To Buy Penny Stocks
You’ll need a trading account to buy penny stocks. You can check out some of the most popular platforms in our article: Best Penny Stock Brokers For Trading & Investing In 2021. Once you’ve found your broker of choice, the process to buy penny stocks isn’t much different from purchasing higher-priced stocks. To buy penny stocks, here are some basic steps to follow:
- Open your trading app
- Search for the penny stock you want to buy
- Navigate to the trade ticket page. This will usually have trading options that include “buy” or “sell” buttons. There also may be choices for trading options if available.
- Decide if you want to “buy now” or if you want to set a “limit order” to purchase shares
- Buying now would entail paying whatever the best market price is. In this case, you’ll use a “Market Order”.
- Limit Orders will involve setting the highest price you’re willing to pay for the shares you want to buy. In your app, find “order type” or something similar, and select “Limit Order”. That should prompt the next selection option which will allow you to enter your Limit Price.
- Enter the quantity of shares you want to purchase.
- Decide how long you want this order to be valid for. Your basic options are usually Good For The Day or Good Until Canceled. Good For The Day will have the order valid from the time you enter it until the end of the trading day. Good Until Canceled will be valid until you manually cancel the order. If you have the ability to trade after-hours, you should have choices for “Extended Hours” or “After Hours” as well.
- Double check your choices. If everything looks good, hit “Buy” and your order will process.
When To Sell Penny Stocks
When to buy or sell any stocks is subjective based on each trader’s style. Some will sell penny stocks where a position is up a certain percentage. Many active day traders will sell penny stocks at set profit targets. They’ll use chart levels to pre-plot their profit targets if a stock increases in price. They’ll also use chart levels to set different levels to sell if a stock declines and they need to take a loss.
Example of Trading Penny Stocks & Using Profit Targets:
Let’s say you’ve purchased a penny stock for $3 a share. You see that in the past, the stock rallied several times to highs of $3.20 but was unable to break above that general area (+ or – 5 cents). You might decide to set your first profit target around $3.20 and peel some profit if or when a stock gets there. At the same time, you see that a consistent level of support for the penny stock is at $2.95. So in this example, you might set a stop-loss slightly below this level.
Now that you’ve got your general levels laid out, you’ve got a game plan. As the price of that stock increases beyond your first profit target, you can move up your stop-loss to protect your gains. I won’t get too detailed in this article about specifics – I want to give a basic idea – BUT if you are interested in learning how to day trade, check out the video below:
Frequently Asked Questions
This was just a quick guide to some of the basics of penny stocks. This is where your journey begins, and it’s essential to learn before you do anything else. Your time is better spent perfecting your trading style and learning how to avoid some of the pitfalls compared to a trial by fire, risking your hard-earned money without knowing anything at all. Here are a few of the other frequently asked questions when it comes to investing in low priced stocks:
Can You Get Rich From Penny Stocks
Yes, you can get rich from penny stocks. But it isn’t an overnight thing. This article covers some of the fundamental things to know when it comes to making money with cheap stocks. To get “rich” with penny stocks, you’ve first got to decide what that looks like for you. What does it mean for you to be rich? Once you’ve figured that out, determine how you’ll use trading penny stocks to your advantage and achieve that. Check out more advanced trading styles here.
Are Penny Stocks Good For Beginners
If you’re brand new to trading or the stock market, in general, you’ve got a lot to learn. Are penny stocks good for beginners? As long as you know how to trade and understand the risks involved, penny stocks can be good for beginners. As discussed above, the most important thing is getting a quality education and understanding everything involved in trading any stocks, let alone penny stocks.
What Is So Bad About Penny Stocks
Penny stocks get a bad reputation thanks to a history of fraud and people losing money. But that doesn’t make them “bad” stocks to trade or invest in. You need to know how to do it successfully to return consistent profits. Learn how to find liquid penny stocks, navigate market volatility, and understand how to set profit and stop-loss targets properly. These are just a few things you can do that don’t make penny stocks bad. Like I’ve said before, the most significant benefit to you as a new trader will be learning and practicing before spending one cent of real money. Trading on a stock simulator can help with this.
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