Should You Buy Penny Stocks In 2020?
Penny stocks are typically known for their high-risk and high-reward. So it makes sense that some new traders and even traditional investors might be a bit intimidated. But rest assured, penny stocks aren’t as “scary” as you might think at first. The main thing to understand is the makeup of stocks under $5.
We’re not just talking about risk, we’re also talking about volatility. It’s also worth mentioning that when a company like Apple has a “big” news event, shares might jump 1%-3%. Penny stocks, on the other hand, might jump 100%-300% or more very quickly.
Similarly, after the news is done circulating, Apple stock might pull back less than 1%. Penny stocks may give back all or even more gains in the blink of an eye. Obviously, this is an extreme case. But it’s important to understand that before deciding if penny stocks are right for you.
Should I Buy Penny Stocks?
This is always a loaded question. Obviously, I think penny stocks are something that when traded correctly and responsibly, are worth your time to learn about. But therein lies the issue. Not everyone is as steadfast and “responsible” when it comes to these cheap stocks. Psychology can play a huge role in your trading style.
Are you someone who plans on hitting a 20% profit target? That’s incredible but what do you do when a penny stock explodes 40% in minutes? Do you take profit because it’s part of your original strategy or do you think “well it jumped 2 times my target so quickly, maybe it goes higher”?
If you can’t relate to the second scenario, I applaud you. Most novice traders tend to “let it ride” if they’re already “in the money” based on their initial profit target. The long and short of it is that you can trade penny stock responsibly, effectively, and still take advantage of bigger moves without having to throw all of your money in at one price point.
Experienced traders will refer to this as “piecing into trades” where you more or less ease into the position. If a trade is panning out the way you want it, you’ll likely cost average up in price. But you’ll also be selling along the way even as you may be buying. The goal is to establish a low enough starting position to stair step up from.
This is where the piecing in plays a part. Identify an amount you plan to invest and then break that up into pieces. Typically the “starting piece” will be small enough to not risk a large chunk of your capital. But it will be big enough to establish a decent average price to grow with.
Can You Make Money With Penny Stocks?
I won’t get overly detailed in this article about how you should or shouldn’t trade. Everyone has their own strategy. But this is the point: have a strategy. Don’t just blindly buy penny stocks because someone told you to or because you read a single article. Take it further and really research what you’re buying and why you’re buying it. As far as where penny stocks fit into a portfolio, that is very much up to you.
But a good rule of thumb that many follow is when it comes to high-risk investments, don’t bite off more than you can chew. In general, traditional traders won’t risk more than they can afford to lose. Again, something you have to decide for yourself or better yet, ask a financial advisor.
Regardless, once you have a strategy and you’ve identified the capital you can risk you might be ready for the next step. The next step is finding penny stocks to buy. Let’s take a look at a few ways of finding top penny stocks:
Penny Stocks With Irregular Volume
Earlier today we talked about several penny stocks with unusual volume. Typically speaking, when there’s higher than average trading activity it usually signals something out of the ordinary is happening, obviously. This could be from the company’s perspective, there might be rumors, or there could be a big industry event at play.
Searching for penny stocks with unusual volume is a good way of identifying potential trends before or as they happen. An easy way to do this is analyze a list of penny stocks, record the average 10 or 15-day trading volume then find stocks where “today’s volume” is higher by 10%-20%. Some people may scale that back to 5%-10%. Find what works for you.
Penny Stock Chart Patterns
There are countless penny stock chart patterns to choose from. There are even more combinations of patterns that traders use as well. We won’t get into every single pattern but for the most part, you’ll want to generally find bullish, bearish, or continuation charts.
The bullish penny stock charts will show you strong uptrends that could signal even bigger breakouts. The bearish penny stock charts will show you strong downtrends that could signal bottoming out for certain stocks. Then the continuation chart will give you a general understanding of potential penny stocks to swing trade.
Penny Stocks With News/Filings
Penny stocks with confirmed news and/or filings are another way of identifying potential opportunities. Remember my Apple vs penny stock example earlier? If you look at the last 7 months of 2020, more times than not, on days with news, penny stocks tend to overreact. Keep in mind that this can be in either direction (up or down). The same holds true for corporate filings. If a company files something like an 8-K it usually means they’re going over a corporate event. Form 4s focus on insider trades.
There are also 13Gs and 13Ds which are filed by investors amassing large positions in companies. Then you have your 10Qs and 10Ks which are a company’s quarterly and annual statements, respectively. You can see the financial health as well as gain insight into management’s take on why the company performed the way it did for that period.
An easy search for that is finding the “management’s discussion” section of a filing. There are also things like registration statements. These can be an issue at times for the simple fact that companies file these to show they’re raising money. In this case, it’s important for you as an investor to understand the price the company’s issuing shares/warrants at, how many shares/warrants, and any other specifics to the financing.
In many cases, the initial announcement of financing tends to pressure penny stocks if the financing price per share is lower than the current retail share price. So be aware of that and know if there’s an active registration statement in place for a company; this would be something like a “shelf registration”. Companies will file 1 big shelf registration, which registers a large number of shares and allows a company to issue them in portions at a price later on down the road that they deem as optimal for the company.
Are Penny Stocks Right For You?
This is a very brief overview – a primer if you will – to test your investing prowess a bit. If you’re done reading this and find penny stocks to be something you’re ready to take the next step with, that’s great! But there’s nothing wrong with taking your time. If you treat these stocks like lottery tickets, you’ll likely make money with them just as frequently. There are ways of becoming a consistently profitable trader.
The grassroots of that begin with proper education. You can start by downloading our free eBook or check out articles like this. You could also take it a step further and learn directly from an experienced trader with hedge fund experience. Different ways you learn will have varying degrees of difficulty but at the end of the day, this will become the foundation of your trading career.