Penny Stocks Are Hot Right Now. Is It Time To Buy?
When it comes to investing, should penny stocks be a focus? Right now, we see rampant buying in these cheap names. Day after day, the most active stocks in the market are those defined as penny stocks.
What Are Penny Stocks?
According to the basic definition, penny stocks are shares of companies trading below $5. So you can see how these cheap stocks can dominate the popularity list. Even on the high end at $5, it only takes a slight move of 50 cents to equate to significant gains. The same can’t be said for companies like Apple (NASDAQ: AAPL), General Motors (NYSE: GM), or Tesla (NASDAQ: TSLA), even though they’re also part of the “popular crowd” right now.
However, if you’re new to this class of stock, you must understand the landscape fully. Some traders like to treat these like lottery tickets. But in actuality, there are real ways of consistently profiting from stocks under $5; you need a strategy that isn’t the same as the one you use in roulette.
Why Buy Penny Stocks?
It’s pretty simple to see the attraction of penny stocks. You hear about significant gains every other day. But buckle up because it’s quite the rollercoaster ride. Just as quickly as the 50-cent move triggers a big rally, it can also deliver a crushing blow. The cheaper the stock, the higher the chances you’ll be dealing with more volatility. For instance, I discussed a $5 stock above, but what about penny stocks under 10 cents? Even a few pennies can be the difference between hitting it big or halving your account. When answering the question, “Why buy penny stocks,” the answer seems simple: to make money, of course.
Few other investments yield such significant returns so quickly. Also, as we’ve seen, the new day traders tend to pick higher-risk assets. This has become one reason that more volume has come into the small-cap arena, in general. With apps like Webull and Robinhood, penny stocks are just a few taps away.
Are Penny Stocks A Good Investment?
Regarding penny stocks being a good investment, you can be the judge once you read our top 7 things to watch. Like anything, those who have practiced and conditioned themselves in a specific field have a competitive advantage over those who haven’t. This applies to the penny stock market as well. Those who have that competitive edge will try and take advantage of you.
If you feel like you can handle the pressure and dangers of penny stock trading, just read some of these principles that penny stock traders utilize each day:
1. Get Past the Fluff & Pay Attention to the Source of the Information
Understand what might be bringing attention to penny stocks. Is there a paid promotion? Did the company release major headlines? Are rumors buzzing among traders on Twitter, Facebook, or Reddit? Penny stocks are speculative in nature as it is, and those trading them typically don’t need a considerable thesis on why they’re good companies.
As we’ve seen, even headlines of raising money higher than the current share price has become a catalyst in many instances. What’s important here is to cut through the noise and understand the root cause of momentum. In this case, you can then gauge if the move is an overreaction to something or if there’s longer-term potential ahead.
2. Don’t Get Greedy
Don’t trade penny stocks with the “hope” that they will get the next 500% runner and miss your shot at a 50% or even 15% return. When you make a strong return, it’s important to remember that no one ever went broke taking profits. There are plenty of ways to make money with these cheap stocks. One trading strategy is called tier trading.
This allows someone to avoid losing trades sooner while staying in winning trades longer. Essentially, you set a specific sum of money you’d like to put toward your trade, then use portions of it, buying penny stocks in tiers and then selling them in tiers. Remember that even if you sell out of a winning position entirely and the stock continues, there should be opportunities to re-enter later on if it genuinely has a strong trend.
3. Focus on Your Own Penny Stocks
Many traders will get distracted by “shiny objects.” Social media has created a platform for people to brag and boast about anything. Is it true? The only person who can firmly give that answer is the one bragging. For this reason, it’s essential to have your own strategy, have your own list of penny stocks, and have your own plan of how to take a profit in a trade.
Finding the “hot new social media” account to “follow” or take advice from isn’t a strategy. It’s you putting your faith in someone hoping that they’re right. Now, seeing what other traders are chatting about doesn’t hurt. But your first step should be focusing on your research and blocking out the noise, as we discussed in Principle #1.
4. Some Penny Stock Companies Avoid Talking About the “Bad Stuff”
Every company wants to become a market leader in one way or another. Maybe it’s the latest electric vehicle company hitting the market. It could also be the oil and gas business that just found a way to reduce its carbon footprint. But, for the most part, these companies are penny stocks for a reason. Many of them will raise money at heavily discounted prices. Other companies will enter into memorandums of understanding (MOU) or letters of intent (LOI) without a firm commitment.
In any case, news headlines act as catalysts for these cheap stocks. It’s important for you as a trader to not only read the headlines but understand what they mean. If a company signs an MOU, that isn’t the same as them signing a definitive agreement, and therefore, it’s only a tiny step in the grand scheme of things. Will companies say, “Hey, this is just a piece of paper that says we might do something”? Probably not, but it’s up to you to understand what terms mean to have a proper strategy.
5. Gravitate Towards High Volume Penny Stocks
Volume matters! To make money trading penny stocks, you must be able to sell your shares. If a company doesn’t have a high enough trading volume, you may get stuck with your shares. So, it’s good to know a little bit about penny stock technical analysis.
Penny stocks that trade less than a certain amount of shares per day are illiquid. Some penny stock traders use 100,000 shares per day as a benchmark. Others use 1,000,000 shares daily, but it is up to you to decide. Aside from the total shares traded, it’s important to understand how that equates to dollar volume. Cheaper stocks may trade millions of shares per day. But if you’ve got a $0.0001 penny stock, 1 million shares are only worth $100 at that price.
You want to find stocks that trade higher dollar volume specifically. The reason for this is that everyone has their strategy. If a stock is trading less than $100,000 in volume per day, on average, how does this fit into your strategy? If you trade with $1,000 per trade, that may be enough volume for you. But if you trade with $50,000 per trade, then that is probably not enough action for you to safely enter and exit a trade.
More On The Basics of Penny Stocks
- Penny Stocks: Frequently Asked Questions About Low-Priced Equities (FAQ)
- How Long Should You Hold Penny Stocks?
- Penny Stock Chart Patterns Every Trader Should Know [Top 5]
6. Penny Stocks Don’t Love You, So You Shouldn’t Love Them
I cannot emphasize this enough. Penny stocks don’t have feelings. No matter how much you “love” a stock, it doesn’t care. Neither do the traders that want to make money with these stocks. Some will focus on holding a penny stock for years, but most traders who get rich with penny stocks treat these as day trades or swing trades. They hold for shorter periods.
Does this mean all penny stocks aren’t worth investing in? No, and as discussed in Principle #2, there are ways to stay in winning trades longer while also taking profit along the way. For the most part, however, I wouldn’t expect certain penny stocks to explode hundreds of percentage points without some larger pullback or correction. Plan your trade and trade your plan. It sounds cliche, but remember, your goal is to make money at the end of the day. “Hoping” for a 500% gain only to see it flop and hold a bag is one of the most frequent things new traders encounter. Don’t be that person.
7. Don’t Bet Against Penny Stocks
Never forget that penny stocks are infamous for their extreme volatility. Volatility goes both ways, but it’s not worth jumping right into a trade because “everyone’s talking about it.” Sometimes emotions will get the best of you. Buying into a hyped-up stock can be the most significant risk you take. Don’t bet against specific trends. In general, when it comes to penny stocks, a big move up typically sees a correction soon after. Knowing this, waiting for that pullback before entering that trade may be best. As I said above, if the overall trend is truly strong, there are likely more opportunities to enter later.