An Introduction to Trading Penny Stocks

Penny stocks refer to small company shares that trade at low prices, often under $5 per share. While penny stocks carry higher risks, they can offer traders massive upside potential. If you understand penny stocks and implement smart trading strategies, you can capitalize on their big price swings.

Trading Penny Stocks: What Are The Risks?

First, penny stocks have a speculative nature. Most companies are new startups in their early stages, so business viability has not been proven. Approximately 90% of penny stock companies will fail.

Second, penny stocks have lower liquidity. As shares of smaller companies, daily trading volumes are light. This makes getting into and out of positions more difficult. Sudden buying or selling can impact prices sharply.

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Finally, penny stocks are prone to manipulation like pump and dump schemes due to limited public information on the companies. Stock promoters can benefit by artificially inflating prices through misleading marketing.

Trading Penny Stocks: What Are The Rewards?

While penny stocks are riskier, they can provide traders huge percentage returns. If a stock trading at $0.10 goes to $0.50, that’s a 400% gain. Even increasing from $0.50 to $2.00 represents a 300% return. These massive price swings are not uncommon with penny stocks.

Second, small investment amounts can yield significant dollar returns. Putting even $100 into a stock at $0.25 per share means owning 400 shares. If it appreciates to $1.00 per share, that $100 investment becomes $400, quadrupling your money.

Lastly, trading penny stocks requires less upfront capital than buying shares of large companies. You can diversify across many penny stocks without needing thousands to invest.

swing trading penny stocks

5 Smart Rules for Trading Penny Stocks

If you decide to dabble in penny stocks, implementing solid trading disciplines and strategies will be key to long-term success. Here are 5 wise rules to follow:

  1. Set Aside Dedicated Capital: Only risk money that, if lost, would not affect your lifestyle or financial wellbeing. Penny stocks carry major risk, so set aside dedicated capital you are comfortable losing.
  2. Diversify Across Multiple Stocks: Do not invest your entire capital into just one penny stock. Diversification will help manage the risky nature. Consider spreading capital across 5-10 stocks in different sectors.
  3. Cut Losses Quickly: Volatility swings both ways with penny stocks. Determine exit points on your trades before entering positions. If a stock drops 7-10%, sell quickly to conserve capital.
  4. Trade Around Strong Catalysts: Look for penny stocks with major upcoming catalysts like product launches, earnings reports, or new partnerships. These events can provide positive price movement.
  5. Use Limit Orders: Market orders guarantee execution but not price. Use limit orders so you enter and exit trades at predetermined prices. This removes emotion from trading.

The Bottom Line

Trading penny stocks can be extremely lucrative thanks to their upside price potential. But you must take precautions by diversifying holdings, managing risk, and implementing smart trading rules. With patience and discipline, penny stocks can provide attractive returns to your portfolio.

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