Last updated: February 3, 2022
TABLE OF CONTENTS
- What Is A Penny Stock?
- The Difference Between OTC, NYSE, & NASDAQ Penny Stocks
- Beginner’s Guide To Trading Penny Stocks
- How To Find The Best Penny Stocks
- Trading Penny Stocks For Beginners
- Identifying Penny Stock Chart Patterns
- How To Make Money With Penny Stocks
- 5 Ways To Make Money With 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 Is A Penny Stock?
Right from the get go, you might be asking a very basic but important question:
What Is A Penny Stock?
The 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. These 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.
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.
Further Clarity On Penny Stocks From FINRA
In addition to the general definition of penny stocks, the Financial Industry Regulatory Authority or “FINRA” further expands on this topic:
“The term “low-priced securities” refers to those securities that are sometimes referred to as “microcap stocks” or “penny stocks.” The term “microcap stock” generally refers to securities issued by companies with a market capitalization of less than $250 to $300 million. The term “penny stock” generally refers to a security issued by a very small company that trades at less than $5 per share.”
While there are differing views on price versus market cap, the bottom line is traders searching for penny stocks to buy are looking for cheap stocks. With that has come growing demand from millions of new traders investing in the stock market and the brokerages they choose to use.
Examples In Corporate Filings
There remains a mystery around the answer to the question: what is a penny stock? While this “confusion” may be in an effort to forego the inevitable (IE being called a penny stock or acting as a broker for trading penny stocks), corporate filings have given even more clarity to the topic.
In many cases, companies trading at lower prices will give a “Penny Stock Disclosure” statement. It isn’t long and drawn out but rather simple in nature to give added clarity to any current or prospective investor looking to buy shares of such a company. The disclosure reads:
“Our shares of common stock are subject to the “penny stock” rules of the Securities and Exchange Commission. The SEC has adopted rules that regulate broker-dealer practices in connection with transactions in “penny stocks”. Penny stocks generally are equity securities with a price of less than $5.00.”
The disclosures further expand in stating that:
“Penny stock rules require a broker-dealer, prior to a transaction in a penny stock not otherwise exempt from those rules, to deliver a standardized risk disclosure document prepared by the SEC, which specifies information about penny stocks and the nature and significance of risks of the penny stock market.”
If you’re wondering what penny stocks are, there are very clear, laid-out definitions for your reference. But at the end of the day, no one buys cheap stocks because they like a definition; they buy them to make BIG MONEY!
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
- What was recently announced and how long ago was it reported
- Are they making timely filings and disclosure statements available
- Does the company have a clearly thought out business plan
- Are they communicating with shareholders frequently (IE if they just put out news, when was the last press release prior to that)
- 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 your 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 that you’re on the winning side more times than not.
In this article we’ll discuss all of the questions you have about day trading penny stocks, how to invest, what certain terms mean and why penny stocks can make you money. Just remember that once you’re done reading, your education doesn’t stop there; it’s just getting started! So without further ado, let’s get into it.
What Is A Day Trading Account & Is It Important?
If you’re just getting started, you’ll want to know your options for opening a trading account. Many new traders will start with a margin account, sometimes by default. This entails depositing cash and then gaining access to margin or “leverage” on the money you’ve deposited. It also offers immediate settlement of cash with most brokers. What that means is if you buy and sell the same stock on the same day, proceeds from that trade is immediately accessible in your account. But there is a downside.
Pattern Day Trader Rule a.k.a PDT Rule
What is the PDT rule?
If your margin account does not have a value of at least $25,000, then you are bound by the “Pattern Day Trader” or “PDT Rule”. This rule restricts you from placing more than 3 day trades within a rolling 5-day period. If you violate the PDT rule, a broker can restrict your account from placing any day trades or even restrict it to closing transactions only for a certain period of time.
But there are ways some traders can seemingly make “endless” day trades without violating the PDT rule. Those with less than $25,000 without margin enabled – also known as a cash account – aren’t bound by the PDT rule. The caveat is that they can only trade with the amount of settled cash in their account and there’s no leverage or margin. In light of this, you should know when funds from certain types of trades settle.
For example, many brokers have a “T+3,” “T+2,” or “T+1” on certain trades. TD Ameritrade, for instance, has T+2 on stock trades and T+1 on options. This means T or “trade day” plus 1 or 2 days for your cash to settle. Regardless, ask your broker for available options on account type during the sign-up process.
The Impact of Social Media on Penny Stocks
The stock market is always changing and new trends are being identified. Since 2020, we’ve seen the impact of social media on penny stocks. It has certainly played a larger and more profound role.
You might remember the GameStop (NYSE: GME) explosion that occurred at the beginning of 2021. While this was in no way the first time social media had an impact on how stocks trade, it did set in motion a new trend for investors to use. As it relates to GME, many traders came together on Reddit, discussing a company that they had an emotional connection to. This led to hoards of people investing in the stock, and the price subsequently rose in the four-digit percentage range in a very short period.
This phenomenon is no a regular occurrence. Reddit, Twitter, Facebook and even TikTok are hotbeds for meme stock hype. While this excitement can relate to news, it often has more to do with investors discussing the stock based on speculation than fundamentals.
Yes, fundamentals are always crucial to consider. However, it’s also important to check factors such as volume and what is being said online. Because penny stocks are extremely speculative, prices can move very quickly. If you are putting certain stocks on your watch list because you read about it on social media, please make sure to do as much additional research as possible to come to your own conclusion on whether you should trade them or not.
How To Find The Best Penny Stocks To Buy
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.
Unusual Volume In Penny Stocks
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.
A Penny Stock Making New Highs or 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.
Gapping Penny Stocks
Similar to highs and lows, penny stocks that gap can also be a good way to find opportunities. On the other hand, they can also help you avoid a losing situation too.
A gap is where the price of penny stocks opens noticeably higher or lower than it was during the previous period. Most gap scanners will focus on opening gaps. Now, I’m not talking about a gap being the instance that 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 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 a 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 & 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 be speculative. Most of the time, stocks that don’t usually trade 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.
High Volume Penny Stocks
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.
Trading Penny Stocks With Low/High Floats
The curse and blessing of penny stock floats. The higher the float, the longer it usually takes for a stock to move (in either direction). Float refers to the number 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 a higher risk. So if you’re looking for low float penny stocks to trade (float of fewer than 12 million shares), you may be better suited as a “trader” than an 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 to 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 essential 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.”
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 actually to break out. However, if a breakout occurs, the trend will continue up until sellers step in.[PennyStocks.com Pro Tip] How 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.
Investors ideally want to enter their positions when the stock bounces back after reaching the second low. In addition, traders will watch 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.
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:
- 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.
- 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.
- 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.
- 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.
- 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.