Learn The Basics Of Making Money With Penny Stocks
Investing in penny stocks is not as difficult as people think it is. With a little help, learning how to day trade or invest in these stocks can be fun, easy, and profitable.
This introduction to trading penny stocks has been developed specifically for the beginner trader. This article will go over some of the basics of buying penny stocks as well as selling them.
This Article Will Cover The Basics & How To Trade Penny Stocks:
- What is a penny stock?
- Where to open a trading account
- How to open a trading account
- How much does a trading account need to be funded, on average
- What types of basic orders can be placed
According to the SEC, the penny stocks are securities issued by small companies that trade less than $5 per share.
“Penny stocks generally are quoted over-the-counter, such as on the OTC Bulletin Board (which is a facility of FINRA) or OTC Link LLC (which is owned by OTC Markets Group, Inc., formerly known as Pink OTC Markets Inc.); penny stocks may, however, also trade on securities exchanges, including foreign securities exchanges. In addition, the definition of penny stock can include the securities of certain private companies with no active trading market.”
These types of stocks are highly speculative with many companies not having significant operations. Depending on the exchange – NASDAQ, NYSE, OTC – there may be little or no reporting criteria. However, due to the speculative nature, this generally entails higher levels of volatility. Therefore it opens up an opportunity for larger gains in a very short period of time compared to “blue-chip stocks.”
Now that we have the pleasantries out of the way and you know the risk/reward of penny stocks, if you’re still looking to trade, you’ll need to open an account. Make sure it’s with a broker that offers the ability to buy penny stocks. We’ve found that it’s much easier to open an account with an online broker than traditional brokerage houses. This is for 2 reasons.
First, many of these traditional brokers don’t accept requests for day trading penny stocks. Second, the time it takes to pick up the phone, reach a live broker, place the order and then have it executed is far longer than it would take to execute a trade with an online broker.
Here are several top penny stock brokers (in no particular order) that allow you to trade stocks under $5:
While there may be other brokers for trading penny stocks, the ones above have been actively used by day traders recently.
Opening up a penny stock trading account is easy. The sign-up process for each broker is similar in most cases. The sites will ask you to fill out a secure form that includes personal financial information and risk assessments to qualify your account. Once approved, you’re one step closer to trading penny stocks.
How Much Should I Fund My Penny Stock Trading Account?
Funding amounts vary, but most brokers no longer require a set minimum. For instance, you can open up an Interactive Brokers or WeBull account with a few hundred dollars. However, on average, the typical opening amount that allows someone to be defined as having the ability to day trade, by law, is $25,000. Now, you may be saying, “I want to trade, but I don’t have an extra $25 grand available.”
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In this event, most brokers still allow you to trade penny stocks but you’re limited on the number of trades you can make. In particular, you’ll be limited on the number of single-day trades (buying and selling a security the same day) you can make. If you don’t have the minimum $25k, you can only make 3 “round trip trades” within a 5 day period.
What Is A Pattern Day Trader?
If you make more than 3 round-trip trades in that time, you could be identified as a Pattern Day Trader and you might be restricted from making day trades for 90 days, by your broker. But what is the Pattern Day Trade Rule anyway?
Suppose you buy penny stocks “today” and sell them “tomorrow” that doesn’t count as a day trade. But when you buy “today” and sell “today,” that is considered a day trade. Do that 3 times in any rolling 5-day period, don’t have the minimum $25k in your account, and now you could get restricted by not meeting the Pattern Day Trade rule requirements.
Most of the time, when traders get hit with the dreaded “PDT Rule,” they’re using a margin account. This allows them to use borrowed money to make larger trades. It also allows them to have cash settle faster. But if you remove margin at most brokers, the PDT Rule may not apply. However, you will be limited to trading with cleared funds. Some brokers will settle cash from stock trades 2 days after the trade has been closed.
If you made a $1,000 trade and profited $500, your $1,500 total cash might not be available for 2 days. Want to make another trade in that time? You’ll have to either utilize whatever is leftover in your account or deposit more funds. Again, each broker is different, so it’s best to consult them about this topic. However, it has been a way not to get hit with a PDT Rule restriction at the end of the day.
Trading With A Smaller Account
This is why some traders with smaller accounts chose to buy penny stocks toward the end of the day and sell them the next morning, depending on the trend.
Here’s another example:
Let’s say you have $5,000 in your account, and you get into a $3,000 position “today.” Later “today,” you sell that position for $4,000. Typically, proceeds from a stock trade settle out at what’s known as “T+2.” This means that after you sell, you’ll be able to trade with that cash in 2 days from the “trade” day (T = trade day).
Going back to our example, “today,” you essentially made $1,000 ($3k principle, sold for $4k nets you $1k profit). But “tomorrow” you’ll only have $2,000 to trade with since your original starting amount was $5,000.
There are ways to trade without “breaking the bank,” know that each broker will vary in what they will allow you to. You should consult the broker individually to find out what they offer with smaller accounts.
What Types Of Basic Orders Can I Place When Day Trading Penny Stocks?
We’ve gone over some of the basics, and now you’re ready to place your first trade. How do you do this? When it comes to certain penny stocks, like OTC Penny Stocks, some brokers will require you to place what is called a “limit order.” This is placed by setting the highest price you’re willing to pay for a given security and then waiting for someone to fill your order. Granted, this may or may not happen every time.
If a penny stock moves up fast, a lower limit order may quickly get bypassed as the stock skyrockets. So in cases such as these, a higher limit may need to be set to have a chance at buying penny stocks at optimal prices.
On the flip side, if there is a consistent market trading the penny stock, a limit order can be placed at the lowest asking price, or you can elect to offer the highest bid price and wait for someone to sell shares to you. This is similar to a standard auction.
However, other penny stocks, usually NASDAQ & NYSE listed stocks, will allow you to day trade using a market order. This tells your broker that you’re willing to pay the going rate for a stock at that time. The benefit is that you buy immediately, securing your price. The downside is volatile penny stocks may dip quickly after you’ve placed your market buy order, leaving you at a loss in the meantime. So it’s best to judge the type of order you want to place based on how a stock moves at the time you’re looking to buy.
I Can Buy Penny Stocks; What About Selling?
When it comes to selling, you can use the same ideology above to sell with a limit order or by using a market order. Once again, in the case of placing a market order, you’re opening yourself up to the market’s best price. This may give you an easier exit but won’t necessarily offer the highest amount of profit. Consult your individual broker before making any buy or sell orders and ask about the types of order processing they offer for penny stocks.
This is just the beginning of your penny stock trading journey. Hopefully, this helped you get started on the right track of figuring out your taste in penny stocks. We’ll be offering many more articles on getting started in this market and more importantly, help you learn the ins and outs of penny stocks. So make sure to subscribe to this site, download the 60+ page eBook, and follow on Twitter, Facebook, Instagram, and even TikTok so you don’t miss any of our important and information-packed articles.