Are Penny Stocks Worth It?
Penny stocks are sought after by new and experienced investors alike. Entire movies are created around hotshot Wall Street brokers making money with penny stocks. So, there is, of course, a considerable amount of hype around these equities. Before you dive right in, you need to understand what penny stocks are and how to position yourself to make money versus lose money.
Definition Of Penny Stocks
Penny stocks are common shares of small companies that trade at low prices per share. Typically, this “low price” threshold is $5 or less. It may seem confusing as most would think a penny stock would have a value of “pennies.” But our good friends at the SEC have outlined specific definitions of what penny stocks are. Furthermore, a penny stock doesn’t need to trade on the OTC Bulletin Board or OTC Market.
There are public companies defined as penny stocks that trade on major exchanges like the NYSE and NASDAQ as well. Aside from the price levels, penny stocks tend to involve more risk. They are typically thinner traded equities compared to other blue-chip companies like Facebook or Google, which owns YouTube.[Read More] Are These Penny Stocks on Your September Buy List?
That means these stocks can come with higher risks. It is essential to decide whether or not to buy penny stocks as there can be situations of dramatic decline due to circumstances outside of normal market conditions. We’ll get into more detail on this below.
Penny Stocks & Volatility
A word you’ll hear repeatedly is that penny stocks are volatile. They are fast trading stocks. Companies behind penny stocks tend to be new to their industry or smaller companies in start-up phases. Typically these companies have low market cap values and can be unstable due to specific financial makeup. It isn’t unusual to see a company with little or no cash or asset value on its books.
But volatility doesn’t just entail fundamentals. The share structure of these companies and lower prices can lead to big swings in stock prices as well. As volatility is dangerous, so are you if you do not know how to trade penny stocks properly. One of the key factors to pay close attention to is how to manage risk. New investors will often treat penny stocks like a lottery ticket. They’ll purchase shares of a company without researching and hope that shares go up. The sad part is that “hope” doesn’t drive market prices.
Research Penny Stocks Before You Buy
As long as you know what you’re doing, you’ll likely have a better chance to profit. If you decide to invest in these stocks, the first step is to find which broker is best for penny stocks. Luckily, there are a number of these penny stockbrokers, including TD Ameritrade, Etrade, Interactive Brokers, and others.
Free penny stock trading apps like Robinhood or WeBull also allow you to buy penny stocks. There is a downside to these free apps. Most will not let you invest in penny stocks that trade on the OTC Markets. Though this isn’t a bad thing, it does limit you to the types of companies you can invest in.
The biggest tip in dealing with penny stocks is to do a ton of research and study what you are about to buy. Most intermediate and professional traders will start by looking at technical indicators and making a list of penny stocks first. From that list, they will begin researching corporate fundamentals and market sentiment. These include things like penny stock news released or digging into a company’s financials.
Once they know some penny stock trading basics, the investor will narrow down the list and prepare to place orders to buy. The benefits of penny stocks to buy are that you can get more shares that compound smaller sums of money quickly. This is compared to what you would invest in large-cap NYSE stocks that would take longer to see similar returns. The key is to treat penny stocks just like large-cap stocks. This isn’t a lottery ticket, it’s an investment, and you need to do your research and manage risk.
Penny Stocks & Technical Analysis
As penny stocks are risky, you must also focus on stock performance and hedging your investment. Many who buy top penny stocks stick to a rule of thumb to never invest more than 10% of their trading account into these stocks. The first thing you must learn is to master stock analysis.
Stock technical analysis refers to evaluating a penny stock based on specific chart patterns. We could go into further detail on penny stock chart patterns, but we’ve got one better. Read more below on our top articles about penny stock technical analysis:
Penny Stocks: The Good and the Bad
The next thing you must learn is how to weed out the good and bad companies. This can be difficult because some companies may be appealing for different reasons. Timing is critical as well. If a particular penny stock on your watch list is there because of a possible technical setup, you need to focus on short-term timing.
If it is there because of a fundamental development like an upcoming FDA trial, then longer-term timing may be a better focus. Furthermore, you should be very cautious if a penny stock is running out of nowhere. Why? There could be a penny stock promotion behind the move (more on this later).
Other things to look at are things like positive indicators of a company. This could be things like positive earnings and new contracts or favorable financing and new partnerships. It’s also important to look at increases in trading volume and positive, industry-wide news. You may want to steer away from companies with financing secured through desperation or significantly discounted terms. Other things like rumors of negativity within the company, poor industry news, and reduced trading volumes can also affect a stock’s price movement.
Penny Stock Promotions
Even though you can make a lot of money with penny stocks, many can be highly manipulated. This can be a result of small market caps and minuscule share structures. Remember that not all penny stock alerts or penny stock promotions are done with malice. But it’s important to note when doing your research. Why do penny stock companies conduct stock promotions in the first place?
Penny stocks have gotten a bad rap mainly due to manipulative actions by questionable characters. But the fact of the matter is that many of these small-cap or micro-cap companies conduct stock promotions or penny stock marketing to get the word out there. Where you have some of the biggest companies in the world getting attention from financial outlets like CNBC or Fox Business, these smaller companies don’t receive the same preference. For this reason, these companies will hire marketing agencies to send out emails, post on social media, and put together market materials to send to people interested in smaller companies.
There are, however, other promotions that have other intentions in mind. Usually conducted by third parties, there are many different schemes out there that companies use to take advantage of investors.
Penny Stock Pump & Dump
The first called the Pump-and-Dump Scheme, sees organizers usually promoting an unknown stock in a newsletter. Often they are paying these newsletters to promote their penny stock for short periods. Inexperienced investors may think it’s a good idea to invest in said stocks. When this happens, the stock price tends to inflate. Afterward, the third party behind the promotion has the power to “dump” their stock at a high profit.
This can leave retail investors with little to no money back after the stock price collapses. Usually, these bad actors have access to more significant amounts of discounted stock. If they decide to sell all or most of it, the sheer quantity is much greater than any retail amount in the market. Simple economics suggest higher supply and lower demand equate to lower prices. During the industry’s early days, marijuana stocks were targets of promotions like these.
Shorting Penny Stocks
Another penny stock scheme is called the Short-and-Distort. This is the polar opposite of the Pump-and-Dump Scheme. Short sellers will borrow shares and sell them right away at a high price just so the company’s stock decreases. Investors can buy these shares at an even lower price to cover their short barrow. That’s where they capture the spread to make a profit. The Short-and-Distort scheme can be successful because regular investors could spread false information about the company.
They’ll utilize things like penny stock chat rooms or penny stock discussion forums to convey the fake news. This scheme can be just as detrimental, if not more detrimental, than a pump and dump. It typically takes far longer to clear up “bad news” than to explain market volatility. The hard part for regulators is tracking down the source of the negative news to begin with.
The Penny Stock Guru Scam
Have you ever seen a post on Twitter, TikTok, or Instagram that seemingly predicted a move for certain penny stocks? It’s usually followed up by another post about the “prediction.” People often fall for the Guru Scam because it is easy to trick people into believing they will become rich if they invest in said get-rich-quick schemes from false advertisements.
It is essential not to fall for the person who promises success if one invests in a “one-time” low sum. I can’t stress this enough: always do your research. Even if you miss out on a short-term move, you also avoid a possibly long-term decline. Also, there is “always another one.” This means that just because you missed out on one stock doesn’t mean there won’t be plenty more later on.
Also, keep in mind that penny stocks aren’t just a US or North American “thing.” Offshore Scams can also be very successful because companies can operate outside the U.S. They have little to no rules since they do not need to register their shares. Penny Stock scammers will sell the stock to investors in the United States at an inflated price. Since these stocks are unregistered, the companies’ stocks drop, and Penny Stock scammers can make a lot of money, leaving investors in the United States holding a bag of worthless stock. ALWAYS DO YOUR RESEARCH!
Know What You Are Doing Before Investing In Penny Stocks
A way to be a better trader and avoid scams is to be able to read chart patterns and conduct extensive research. If you can do this, you will be able to understand how stocks behave in specific market conditions. You’ll also be able to spot extraordinary occurrences like promotions or schemes more efficiently.
Although you can’t predict the future, you can identify these things as you become more experienced with penny stocks. You may want to keep a trading journal to record observations and results of a company or your trades.
In order to see success in trading the best penny stocks, you must be able to read chart patterns, invest in companies that interest you, correctly research companies (their past, present, and future), and do not be afraid to take a risk. If you never take a chance with penny stocks, you will never see the reward. It might not be a bad idea to follow some of the reputable stock chat rooms. When you can find a true mentor to help you learn on a daily basis, it can cut the curve dramatically. Just like with penny stocks, it’s important to do your research and identify the best educational platforms online.
There’s much more to learn about penny stocks. But hopefully, this article helped you get started with some of the basics. Never stop learning, as investing is a lifelong focus. As you grow as a trader, so will the amount of information you’ll have in your utility belt.