New To Penny Stocks? Your Questions, Answered
Look, we aren’t born experts on the topic of penny stocks. But we have all seen a lot of things involving these cheap stocks. I’m sure plenty of new traders have questions they want to ask before buying these highly volatile stocks.
With so much that has happened over the last year since the pandemic, penny stocks have gotten a lot more attention. That’s likely due to a few different factors. First, many of the leading names in different industries fell victim to the COVID-19 sell-off in March & April. You saw companies like Hertz (OTC: HTZGQ), Party City (NYSE: PRTY), GameStop (NYSE: GME), Chico’s FAS (NYSE: CHS), Nautilus (NYSE: NLS), Tupperware (NYSE: TUP), & countless others fall to the depths of penny stock territory.
It’s almost ironic in some cases. Had you asked someone if they traded penny stocks in 2019, you’d likely get a mixed response. Some would say yes, while others would express their disdain for these cheap shares. They might even emphasize that they think penny stock companies are totally worthless. But here we are, 1 year after the pandemic sell-off introduced plenty of “traditional” traders and those who would never touch stocks under $5, paying close attention to them in 2021.
The rise of social media has also given a megaphone to retail traders. This is not in the traditional form of someone saying, “these are great stocks!” but rather in the form of market activity. The Reddit army descended upon the stock market this year and showed institutional funds that mom and pop investors could, in fact, have an impact on the markets.
Penny Stocks FAQ
Millions of new traders are learning how to make money with penny stocks right now. The major difference between those who consistently profit and those who are inconsistent comes down to how they treat these trades. What I mean by this is that hype can easily cloud someone’s trading strategy because penny stocks have the potential to rise to meteoric levels. If you’re new to the market or looking at how to day trade, starting with the basics is important.
So let’s break down some of the more frequently asked questions when it comes to learning about penny stocks for the first time:
What Are Penny Stocks?
The first question many ask: What are penny stocks? At the heart of this topic is the standard definition of penny stocks. According to the stock market’s overseeing body, the Securities & Exchange Commission or SEC, penny stocks are shares of companies that trade at $5 or less. Based on popular opinion, retail investors classify penny stocks as those that trade below $1 per share. No matter where you stand, the definition of penny stocks pertains to companies that offer cheap shares in the market.
Are Penny Stocks a Good Investment?
This is another question based on personal opinion. However, most will agree that penny stocks are high-risk investments and shouldn’t take up a major piece of your long-term portfolio. Are penny stocks a good investment? As the sole decision-maker of your investment goals, it’s totally up to you. At the end of the day, you need to understand that the lower the stock price, the more volatility plays a role.
If a stock is trading at $1, a move of $0.05 equates to 5%. If a stock is valued at $0.10, a move of $0.05 equates to 50%. You be the judge. Warren Buffett’s strategy is to invest in companies that have an opportunity for growth and show firm value prospects. Most penny stocks are start-up companies with minimal (if any) revenue and speculative business models.
Does this mean you shouldn’t invest in penny stocks? Thanks to the pandemic, the “investment” approach of holding stocks for 1 year or more has actually paid off. This is not only for the companies I mentioned above but also for many others. While some remain penny stocks to this day, those shares have risen from under 10 cents to over $2 in many cases. Furthermore, we’ve seen plenty of companies with exposure to COVID treatments explode over the last 12 months. I think it all comes down to your trading style and how you handle risk.
Can You Make Money With Penny Stocks?
Yes, you can make money with penny stocks. How you make money depends a lot on how you trade. If you are greedy when a stock is up 100%, and you think it might run to 200%, you might be at risk of losing your whole position.
If you have a set plan and take profit when stocks are up a certain percentage (some traders start at 20%), then you’ll likely have better odds of capitalizing on smaller moves. Your trading strategy will determine your potential to make more (or less) money with penny stocks.
Novice investors tend to treat penny stocks like the lottery. They risk whatever they can to make money. But they don’t take into account an actual strategy. At the end of the day, if you treat penny stocks like a lottery ticket, expect to “win at stocks” just as much as you win the lottery. On a side-note, if you win the lottery a lot, let me know; we got to talk.
Herein lies an interesting approach to day trading penny stocks. It’s called a tier trading method and involves buying and selling in different tiers. Let’s say you have $1,000 you’re willing to allocate to a certain stock. You might take a “starter” position with 25% of your total allotment; in this case, $250. If the trade begins working in your favor, the strategy suggests taking a bulk tier of 40-50% or around $500 in this example. As the trade continues working in your favor, you sell off a portion of your position, and you might buy back in as the stock moves further in your favor. This allows traders to stay in winning trades longer.
It also allows to cut out of losing trades quicker with minimal monetary loss. Let’s say the trade didn’t work out after tier 1. Now you’re taking a percentage loss on $250 instead of $1,000. You not only avoided a losing trade, but you also protected your capital by adjusting to this type of trading strategy.
Are Penny Stocks Risky?
Penny stocks are risky by default. Most companies with stocks trading at low levels have risky business models. They likely have minimal to no revenue, and their growth prospects are typically slim.
However, when it comes to the “long-shot” play, penny stocks are like Rocky Balboa against Ivan Drago when they hit it big. Though some penny stocks like FNMA and FMCC are government-backed, it doesn’t mean they are any less-risky than other penny stocks. Keep this in mind.
How Do You Buy Penny Stocks?
When it comes to buying penny stocks, it’s as easy as a few clicks of your mouse. On your broker’s platform, find the stock you want to buy, open up an order form, enter your share amount, and click the ‘Buy’ button.
Compared to the old days of buying stocks, you no longer need to do it by phone. Today, you can open up an account at ETrade, TD Ameritrade, Robinhood, Charles Schwab, Interactive Brokers, or several other online brokers to sell or buy penny stocks. Something to keep in mind is: how quick is my trade execution, and what fees are involved with buying penny stocks?
Many times these two things can be different. When it comes to free penny stock trading platforms, the “no fee” structure means you have to give up other things like faster trade execution. Compared to ETrade, free platforms may execute trades slower. Needless to say, buying penny stocks isn’t as hard as one might think. Choosing which stocks to buy, however, can be.
Why Penny Stocks?
These are just a few of the most frequently asked questions about penny stocks. Ultimately, you need to ask yourself why you’re looking for penny stocks in the first place. Is it because of the high-risk, high-reward mentality? Maybe it’s because you saw something in a movie.
On the other hand, maybe you’re a pro at trading, and penny stocks give you opportunities to take small sums of money and turn them into big profits. No matter what you think about penny stocks, the fact remains: companies go public to raise money and, in doing so, offer up opportunities for investors to make money.
The class of cheap stocks regarded as penny stocks have become a mainstay for those looking to invest smaller capital with the hope of bigger returns. At the end of the day, it’s up to you to decide on your own strategy and determine if penny stocks are right for you.