What Are Penny Stocks
Penny stocks are shares of companies that can be purchased for less than $5. Despite certain popular beliefs, “penny stocks” are not always “small-cap stocks,” “micro-cap stocks,” “nano-cap stocks,” or even large-cap stocks. First, to understand if penny stocks are good for beginners, you’ll need to understand the basics. We just gave you the definition above. Now let’s briefly discuss what these “caps” mean.
Market Capitalization Defined
The market capitalization or “market cap” is a term used to identify the value of a company based on its current market price multiplied by the number of shares outstanding. For example, as of this article, shares of Apple Inc. (NASDAQ: AAPL) trade at around $160 per share. There are roughly 16.39 billion shares outstanding, which puts the AAPL stock market cap around $2.7 trillion. So, when traders and investors search for certain ABC-cap stocks, they’re looking for the market value of the company. Generally speaking, market caps are broken down into different segments:
- Mega-cap stocks: These are companies with market capitalizations above $200 billion. Apple, Amazon (NASDAQ: AMZN), Tesla (NASDAQ: TSLA), etc., fall into this category.
- Large-cap stocks: Companies with market capitalizations of $10 billion – $200 billion.
- Mid-cap stocks: Companies with market capitalizations of $2 billion – $10 billion.
- Small-cap stocks: Companies with market capitalizations of $300 million to $2 billion.
- Micro-cap stocks: Companies with market capitalizations of $50 million to $300 million.
- Nano-cap stocks: Companies with market capitalizations below $50 million.
Penny Stocks vs. Small-Cap Stocks
Unlike popular opinion might suggest, not all penny stocks are small-cap stocks, and not all small-cap stocks are penny stocks. Take, for instance, Banco Santander (NYSE: SAN). As of this article, shares of SAN stock are trading between $2 and $3. It is considered a penny stock based on the fundamental definition regarding price. Is it a small-cap stock? No, and with a nearly $50 billion market capitalization, it’s roughly the same size as Lululemon Athletica (NASDAQ: LULU). One apparent difference is that Santander has more than 17 billion shares outstanding, and Lululemon only has 129 million.
On the other side of the coin, you’ve got companies like Digital World Acquisition Corp. (NASDAQ: DWAC). This Special Purpose Acquisition Company is set to become the new home of former President Donald Trump’s Truth Social. Shares are trading above $50 as of this article. With fewer than 40 million shares outstanding, DWAC stock is technically considered a small-cap stock. It is not a penny stock based on the price and another example of the different definitions you should learn before searching for penny stocks to buy.
Are Penny Stocks Risky?
Yes, penny stocks are risky. But it shouldn’t come as a surprise that penny stocks come with a higher risk than other securities. Why are they riskier? They are much more volatile due to lower prices, fewer outstanding shares, and lower liquidity. Also, consider that the underlying companies are typically newer or smaller businesses in their early stages that may encounter several obstacles in terms of growth. That being said, penny stocks also give investors an opportunity to generate some serious profits over a short period.
Whether penny stocks are right for you or not is something that only you can decide. Usually, the answer will correlate with your risk tolerance as an investor. This may be a discussion to have with your financial advisor as they may tell you to steer clear due to the risks involved. However, there are ways to trade penny stocks that decrease the risks while watching your portfolio generate significant gains.
You’ve got to start somewhere, right? Some of the greatest companies began their journey as penny stocks and are now well-known household names. The key is to identify high-quality penny stocks, especially if you’re looking to invest for the long term. Keep in mind that the purpose of a business is to generate cash. Therefore, finding penny stock companies that are making money or strategically placing themselves in the position to generate revenue is essential. By avoiding low-quality companies, you are considering increasing your odds of potentially discovering a real winner.
How to Trade Penny Stocks
To trade penny stocks, you’ll need a few things. First, you’ll need a brokerage account and cash to fund it. Consider paper trading before diving in headfirst if you are new to trading. Paper trading is a way to place trades in real stocks but only invest in them with make-believe money. This allows you to see how your trading decisions and strategy would have played out and enables you to learn from mistakes. You’ll also want to know the dos and don’ts of penny stock trading.
If you decide that penny stocks are for you, remember to learn what you can and buy what you know. Keeping emotions in check is a fundamental aspect of trading any stock to avoid making rash or impulsive decisions. Personally, I think that penny stocks should be a part of everyone’s portfolio. They not only challenge you as an investor but have the potential to be very rewarding. However, the choice is yours. The first step is learning how to make money with penny stocks.
Are Penny Stocks Good For Beginners?
Today, we covered some of the very basic details of penny stocks and how to decipher the difference compared to other companies. There are plenty of risks involved with trading or investing in penny stocks, which is to be expected. If the risk hasn’t scared you off yet and you’re new to trading, it might help to get educated on trading basics first. Whether you’re looking for penny stocks to buy or higher-priced stocks to invest in, no education is just as bad as blindly buying a random stock you know nothing about.
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