penny-stocks-101

Last updated: October 16, 2020

Trading Penny Stocks Can Be One Of The Best Ways To Profit From The Stock Market Today

What You’ll Learn About Penny Stocks:

Understanding how to buy penny stocks is a huge benefit when approaching the stock market. If you can feel comfortable trading these volatile and cheap stocks, you can consider yourself among a tried and true group. This year learning how to trade penny stocks has reached a feverish pitch. First thing’s first, however, you need to know exactly what you’re buying.

What Are Penny Stocks?

While many people will have their own definition of penny stocks, according to the Securities and Exchange Commission, the penny stock definition is any share of a public company trading below $5 per share. Theses companies also have smaller market capitalization.

Typically, penny stocks represent shares of companies that are either start-up stage or have yet to establish a significant lead in their industries. That doesn’t mean penny stocks are bad, however. In many cases, these companies are focused on cutting edge innovation. This is why traders and investors alike will buy them based on speculation instead of general fundamentals.

definition of penny stocks

The obvious attraction to trading penny stocks is making money quickly. Not only that but because of the inherent volatility, these cheap stocks can see massive rallies of 100% or more within a single day. This is what is so attractive for investors and the crazy part is, sometimes traders won’t even know what they’re buying. They just focus on a penny stock’s symbol. Here’s where a good understanding of trading comes into play. You have things called catalysts that act as a trigger for penny stock breakouts.

Knowing what the catalyst is and what traders are paying attention to in order to develop their trading strategy is important. It’s very easy to get caught up in the hype and lose all of your money; possibly more if you use margin. So this is why it’s so important to know how to trade penny stocks and what to watch before hitting the buy button.

OTC Penny Stocks, NASDAQ Penny Stocks & NYSE Penny Stocks; Do You Know The Difference?

Again this is something to have a clear understanding of especially if you’re new to penny stocks. Many of the reasons traders will stray away from things like OTC penny stocks has a lot to do with reporting requirements. This refers to the company’s responsibility to put out timely information through the submission of public filings to the SEC. Today, there are different tiers of the OTC, each with its own minimum for publicly available information. However, there are also minimum price requirements as well.

When it comes to NASDAQ and NYSE penny stocks, the exchanges will require the companies to keep their prices above $1. In the event shares dip below that level, the exchange may end up delisting that penny stock, which would then trade on the OTC.

Are OTC Penny Stocks bad? No, they aren’t “bad” but you should understand that you may need to do a bit more research before buying them. Understand what the company does, when it last released news, is there a business plan and a clear end game. Things like this can help you sift through the best penny stocks to buy and ones to avoid.

Then again, the same holds true for NYSE and NASDAQ penny stocks. Even though they may be “listed on a major exchange” it doesn’t mean they’re the best penny stocks to buy. Make sure you run them through the same penny stocks checklist:

Penny Stocks Check-List

  1. What was recently announced and how long ago was it reported
  2. Are they making timely filings and disclosure statements available
  3. Does the company have a clearly thought out business plan
  4. Are they communicating with shareholders frequently (IE if they just put out news, when was the last press release prior to that)
  5. How is the company staying afloat (Are they constantly raising money or are they generating profit, etc.)

Beginner’s Guide To Trading Penny Stocks

Making money with penny stocks is a sweet science but one that takes practice. These cheap stocks are highly volatile and with that, very risky. But if you can make a living trading these stocks, what more could you ask for?

The appeal of quick returns is quite obvious. Who wouldn’t want to invest a few hundred bucks to make a few thousand? But at the end of the day, 9 out of 10 traders will end up losing money and quit. Who do they blame? The companies, penny stocks in general, a “mentor”; anyone but themselves get blamed. The reality is that the only person in full control of your trading is you.

So if you really want to make trading penny stocks a usable skill, education is the first thing you should think about before placing a single trade. The fact is, flipping penny stocks is harder than most will admit.

Not only does trading strategy play a role, but you’ve also got to consider the psychology of trading. There’s no magic spell to making money with penny stocks. But there are things you can do to ensure you’re on the winning side more times than not.

How To Find The Best Penny Stocks

When it comes to finding the best penny stocks to buy, there are easier ways than just picking a random ticker trending on Twitter. First thing’s first, “the best” refers to stocks that have the best opportunities to make a strong move.

Here’s where a good penny stock screener will come into play. You’ve got your pick. Some of the best penny stock brokers offer built-in screeners and options for you to design your own. Personally, I think TD Ameritrade has a few good options. You could also use things like Trade Ideas or FinViz to put a scan together to find stocks under $5 that meet certain criteria.

Penny Stocks With Unusual Volume

One of the first things you’ll want to identify is stocks with irregular or above-average volume. This method allows you to more or less “follow the money” because when there’s unusual volume, there’s typically an “unusual” event that could act as a catalyst. For instance, certain penny stocks may hit a scan for “unusual volume” even if the company itself doesn’t have any news. This would pertain to something like industry-related news.

For instance, when cannabis was legalized in Canada, most of the marijuana penny stocks broke out big. Not many attested that to their own news but rather the sector move in response to the big industry news. Sometimes, unusual or high-volume penny stock screeners can pick up on the groundswell before the average Joe investor puts the puzzle pieces together.

Penny Stocks At New Highs/Lows

When we talk about significant levels on a penny stock chart, the daily range should be considered. At daily highs, you might be able to identify new, bullish trade opportunities based on market momentum. There’s a reason stocks rise and if you see volume building in tandem, you can probably bet on a stock making another move. While this isn’t foolproof, it is one way to identify potential penny stocks to buy. Some traders look for new daily highs and lows then mark it down as the pivot point to determine an entry level.

For instance, let’s say a penny stock reaches its initial morning high. Some traders will sit back and wait for the pullback from those highs before buying penny stocks. Most of the time, this tactic proves correct. If the momentum is truly strong, penny stocks will rebound after pulling back.

In that case, just waiting a few moments can position you at a much better cost average compared to buying “at the top”. As far as new daily lows go, it’s a similar strategy except you’re dealing with a downtrend. So you’d want to wait for and see if larger buying volume comes in after a stock reaches a new low. Sometimes a “bottom bounce” can prove just as profitable as buying into a bull run.

Penny Stocks And Gaps

Similar to highs and lows, penny stocks that gap can also be a good way to find opportunities. A gap is where the price of penny stocks opens noticeably higher or lower than it was at during the previous period. Most gap scanners will focus on opening gaps. Now, I’m not talking about a gap being the instance than a stock closes at $1.01 and opens at $1.03. I’m talking about a true gap where the penny stock closed at $1.01 and is trading at $1.50 the next day at the open.

Gaps are typically caused by some type of catalyst that creates positive or negative sentiment. Similar to “unusual volume,” these catalysts don’t need to be from the companies themselves. For instance, oil and gas penny stocks dropped the last time there was an oil glut.

In this case, the gap down created an opportunity for long-term oil traders to buy energy penny stocks at much lower prices. This proved to be a winning formula as oil stocks are very cyclical. But you wouldn’t know that unless you understand some of the industry’s fundamentals.

This goes back to my original point: Education is EVERYTHING. Just because something gaps up, doesn’t mean you should buy it. Buyers from earlier in the week/month/year will see this as prime opportunity to become sellers. On the flip side, a gap down doesn’t always mean shares are “cheap”. It could just mean investors are losing confidence and prices can keep going lower. Understanding the fundamentals of individual companies and/or industries will help you identify the real opportunity in front of you if there is one.

Trading Penny Stocks For Beginners

Ideally, you’ll want to set yourself up for success and these scanners are just the start. More or less, they will give you the first step in building a list of penny stocks to watch. Next you’ll want to do a deeper dive. Once you’ve identified your “unusual volume”, gappers, new highs/lows, you’ll want to see why things are doing what they’re doing.

Penny Stocks With News

First, does the company have news or is it industry-related? Things like FDA approval or a new joint venture might mean the market is bullish because of a true corporate event. On the other hand, if penny stocks are moving without any direct catalyst, it could just be speculative. Most of the time, stocks that don’t usually trade at all, but receive a sympathy trade on speculation won’t have a lasting bullish trend. Remember, you want to find stocks with a strong backbone when it comes to trends. When it comes to penny stock news, you’ll want to take these different things into account.

Penny Stocks With High Volume

Volume is the lifeblood for those trading penny stocks. The whole reason you want volume is to enter and exit trades easily and at optimal prices. If penny stocks don’t usually trade, it can be hard to buy at the price you want or, worse, sell at the price you want. Higher than average volume is also good to look for. It could mean there’s growing interest in the penny stock and likely something that could compound over a certain timeframe.

Penny Stocks With High/Low Floats

The curse and blessing of penny stock floats. The higher the float, usually, the longer it takes for a stock to move (in either direction). Float refers to the amount of shares available to trade in the retail market. When it comes to low float penny stocks, this is where you see the multi-hundred and thousand percent moves. But it’s also higher risk. So if you’re looking for low float penny stocks to trade (float of less than 12 million shares), you may be better suited as a “trader” than investor. Most of these types of stocks will rally big and then come back just as quickly.

Identifying Penny Stock Chart Patterns

Gains with penny stocks are heavily dependent on stock prices going up. While you can short penny stocks in some cases, the general idea is buy low and sell high. So you’ll want to be able to identify bullish penny stock chart patterns.

Penny Stock Chart Pattern: Bull Flag

When trading penny stocks, it is very important to identify consolidation and continuation. A bull flag chart pattern happens when there is a strong upward move generally in 1-3 green candles. The stock then consolidates. We’ll see lower highs but constant lows forming a flag meaning we won’t see “lower lows”.

bull flag penny stock chart pattern

Like any other significant price movement, the volume must be strong. If a bull flag forms on lighter volume, it’s likely going to be harder for the stock to actually break out. However, if a breakout occurs the trend will continue up until sellers step in.

[PennyStocks.com Pro TipHow To Use Penny Stock Charts

Penny Stock Chart Pattern: Double Bottom

As important as continuation patterns are, reversal patterns can be just as fruitful for investors. A double bottom penny stock chart pattern occurs when the price of a stock reaches the same low two times and then rallies back up. It usually looks like a “W” on a stock chart.

double bottom penny stock chart pattern

Investors ideally want to enter their positions when the stock bounces back after reaching the second low. In addition, traders will keep watch on how the stock trades over the next few days to confirm an uptrend.

Penny Stock Chart Pattern: Golden Cross

The golden cross is one of the most sought-after chart patterns. It’s can also be considered a technical indicator as well. A lagging indicator like the 50 or 200 Day Moving Average confirms trends but doesn’t actually predict them. That’s because they’re based on previous data. A golden cross happens when the 50-Day Moving Average crosses over the 200-Day Moving Average.

golden cross penny stock chart pattern
You can see on the chart that the Blue Line (50-day Moving Average or “MA”) is on the verge of crossing up and above the Red Line (200-day MA) signaling a potential “Golden Cross Chart Pattern”

This is considered very bullish and a sign that a strong uptrend could be forming. Traders use the golden cross to make positions for longer-term trades. Seasoned traders will look for more indicators along with the golden cross so confirm their decision to buy penny stocks.

How To Make Money With Penny Stocks

Can you invest in penny stocks? Of course, you can and who am I to tell you any different. But I will warn you that due to the increased volatility, most people will make money with penny stocks by trading them.

Typically, a shorter-term view of the stock market is ideal for trading penny stocks. It also helps if you encounter a bit of loss too. Ideally, the psychology of trading should be more akin to a machine than a human being. Humans have emotions, machines do not so it’s usually harder to regroup after a losing trade especially if you’re a new trader. You’ll come to learn that small losses will be overshadowed by your larger gains.

But the goal should be consistency and a proper strategy & plan can help. If you aim for the fences every time, you’ll likely lose more than gaining. So set your sights on consistent profitability. Leaving money on the table is better than taking a huge loss. Also, if a trend is truly strong and you “sell early,” you’ll have a chance to buy back in. Just remember that be

Becoming a good trader is just like anything else. It takes time, dedication, and education to perfect your craft. If you start trading penny stocks and don’t immediately become a millionaire, that’s ok. The goal is to consistently make money; not win the lottery.

5 Ways To Make Money With Penny Stocks

While there’s no secret formula, hopefully, this overview gave a bit more clarity on making money with penny stocks. If you’re a short-story reader, let’s sum up a few things for you with these 5 tips for trading penny stocks:

  1. Let Your Emotions Go

    Become a trading machine, literally. Make sure you have a clear plan in place and execute on a strategy. Trading penny stocks is a way to make money, not win the lotto. Consistency is at the top of the list. Big wins and big losses can cloud your judgment. So make sure you continue to remind yourself of your goal to become consistently profitable not consistently emotional. This includes taking into account but not falling prey to hyped-up penny stocks. Whatever you read online from message boards and social media should be taken into account but not used as the main reason you buy penny stocks.
  2. Find Penny Stocks With Volume

    Volume is your friend, always. High volume penny stocks allow you to enter and exit trades easier. When it comes to low float penny stocks and high-volume, this can present the unique opportunity to see huge moves. Trade accordingly but understand that higher volume gives you the best opportunity to secure more desirable conditions for buying and selling.
  3. Trade Penny Stocks

    While there are always exceptions to the rule, penny stocks are usually better as trades than investments. Taking advantage of quick moves in stock prices give you the unique ability to benefit from speculation. Rarely will you find “the next Apple” as one of the stocks under $5. But average investors falling in love with hype can give you the option to take advantage of the short term momentum created by the “love”. A good rule of thumb if you truly believe in a certain company: hold a small core position. This will allow you to make most of your short-term profit from trading. But if the company really becomes big, then you have a core position to average down with.
  4. Time Is On Your Side

    When it comes to penny stocks, there are plenty to choose from. That’s it. If you make money with penny stocks and they keep running, that’s ok. Making money is the goal; not holding the bag because you didn’t sell. If a trend is truly strong, you’ll have more opportunities to get in on the next move. Trading is all about doing it 1 trade at a time. Set a target of a realistic amount of money you want to make per day. Just for reference, there is an average of 21 trading days per month in a 365 day year. Could you successfully make $100 a day? If so, that’s an extra $25k a year. It all adds up.
  5. Education, Education, Education

    I put this last because it should be the last thing you take away from this. Education is the most important thing you can invest in. I’m not talking about buying a subscription to a stock picking service but actually investing in trader education. I compare trading penny stocks to driving a high-performance car. It can be fun, rewarding, and if you’re good at it, you can become a professional and make the big bucks. But you wouldn’t jump into an F-1 car without knowing how to even put on a helmet. Similarly, trading penny stocks takes time and tons of learning.

Are You Ready To Trade Penny Stocks?

Making money with penny stocks seems simple. But actually trading them may not be for everyone. You need to understand risk, be able to handle high volatility, and be able to quickly shift focus at times.

[Read More] How To Make Money Day Trading Penny Stocks

But if you are ok with all of that, then penny stocks might be right for you. I would suggest starting out with more education. I also would point you to get a paper trading account set up before using real money. Paper trading allows you to test your strategy without losing money if it needs more work. It will also allow you to get more comfortable with the stock market, in general.

I hope this brief overview helped give a better understanding of penny stocks. We also offer our subscribers free access to a 60+ page eBook all about trading penny stocks. If you have any questions for us, you can email us or feel free to drop a comment below.