What are penny stocks
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.
Penny stocks are low-priced shares of a relatively small company (think micro-cap & small-cap). The Securities and Exchange Commission considers shares trading under $5 a penny stock. However, most investors consider shares below $1 penny stocks. Shares of these companies (i.e., penny stocks) usually trade over-the-counter (OTC) in the U.S. and on the TSX-Venture / Canadian Securities Exchange (CSE) in Canada – not major exchanges like the NASDAQ, New York Stock Exchange or the Toronto Stock Exchange (TSX). As a result, the liquidity of many penny stocks is questionable; investors should take this into account prior to purchasing shares.
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.
As with all things, there’s a dark side to the world of penny stocks. Penny stocks are underfollowed in nature, which leads to a lack of transparency. This murkiness sets the landscape for all types of fraudulent activity such as stock manipulation. One of the most popular forms of stock manipulation in the penny stock space are “pump and dump” schemes – wherein shares of a company are promoted, in order to “pump” up the share price. As shares rise, the organizers of the scheme simultaneously sell – a.k.a. “dump” – their shares to oblivious buyers. Once the activity stops, investors are left holding the bag of a potentially worthless security.
On the other hand, the fact that penny stocks are underfollowed also provide tremendous opportunity. With all of the large Wall Street firms focusing their research efforts primarily on blue-chip companies, penny stocks tend to be overlooked – which can result in mispriced securities. Investors witty enough to take advantage of these mispriced securities can go on to make incredible returns which are unheard of in the blue-chip world. Although the potential loss when buying penny stocks is 100%, the upside can be many times higher.
Many Household Names Started As Penny Stocks
At some point, many of the household names we’re all familiar with have traded as penny stocks – or at penny stock levels. Among these include Ford, where shares went as low as $1.80 during the great recession and now are many times higher in value.
Of course, the key to successful investing is performing thorough due diligence. This can’t be emphasized enough, especially in the volatile world of penny stocks. Regulatory agencies, such as the SEC, provide educational resources for penny stock investors, along with a variety of other information. Employing a disciplined approach to investing, and understanding the trade-off between risk and reward, should be key to anyone interested in buying penny stocks.
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’s The Best Trading Strategy?
When investing, a healthy balance of fundamental analysis and technical analysis is necessary to make a well-rounded decision. Both styles of analysis offer a considerable amount of useful information – fundamentals provide insight into the company’s core business model, as well as the overall financial health of the company. On the other hand, technical analysis revolves around the supply and demand for a company’s shares in the open market. When employed properly, investors stand to benefit immensely from the breadth of information made available.
Fundamental Or Technical Analysis?
Fundamental analysis is typically employed with a longer-term investment horizon in mind. As mentioned before, the fundamentals focus on the company’s underlying business, and also takes into account any impacts (short- or long-term) to the company’s margins and revenue. Revenue generation and costs are typically what determine a company’s bottom line (also known as net income, or simply earnings) and cash flows. Earnings and cash flows are then used to value the company. Whether the focus be on earnings, or the company’s financial stability, fundamentals help get a solid picture of the company in question and where it may be headed in the future.
Some widely used fundamental ratios include the price-to-earnings (P/E) ratio, which indicates the company’s value relative to their net income. To calculate a company’s P/E ratio, you simply divide their share price over their earnings per share in the past year. Typically, the S&P 500’s historical P/E ratio has averaged around the mid-teens. Yet with a lot of company’s growing incredibly fast today (e.g., Amazon, Facebook), these multiples tend to be high because they are factoring in expected growth in earnings. Other ratios include the price-to-book (P/B) ratio, price-to-sales (P/S) ratio, and enterprise value-to EBITDA ratio (EV/EBITDA).
Technical analysis, however, is primarily employed in short-term investments. It allows investors to get a feel for the market’s sentiment on the stock. One day, there may simply just be more buyers than sellers – the next day this may change. Despite this, technical analysis is often used to identify trends supporting a long-term investment thesis. There is a myriad of technical indicators, and analysts argue that indicators are most effective when used with each other, as opposed to just selecting one indicator and focusing on that one indicator alone.
Some popular technical indicators include Bollinger Bands, Simple Moving Average, and the Relative Strength Index (RSI). The Bollinger Bands allow investors to see the lower- and higher-end of a stock’s average price over a pre-selected period. A Simple Moving Average obtains a moving average of a company’s share price over pre-selected periods of time. The Relative Strength Index allows investors to identify whether shares are overbought, or oversold. These are just a few of the technical indicators out there. The versatility offered by technical indicators is what makes technical analysis a widely embraced practice, and the reason it will continue to be used well into the future.
Of course, as with many things in life, a healthy balance between the two is best – typically, the fundamentals will be the backbone of investment thesis, with technical analysis playing a key role in the entry and exit. The fundamental and technical aspects of the investment thesis will constantly be re-evaluated. Plenty of fundamental ratios are constantly being monitored to ensure valuations are inline with the thesis, and the company remains safe. The technical analysis portion will portray the market’s sentiment on the security and determine the ideal entry and exit point.
Short Term Vs Long Term Investing In Penny Stocks
For many investors, there are two types of time horizons: short-term and long-term. How individuals define these terms varies greatly. Short-term investments may last just several minutes, to several months. On the other hand, long-term investments could last up to several decades. As with many things in finance, the holding period of an investment greatly depends on the situation of the investor. A young student can afford to have money stashed away for several decades, whereas an older individual may need the money within one year. Although there is no correct way to invest money, there are certain benefits associated with the two which should be used to compliment an investors financial situation.
The word trading gets thrown around quite a bit, which implies an active approach to investing. That is, constantly entering and exiting positions to generate returns. Investors are hearing more about high frequency trading, which takes short-term investments to a whole new level – investments literally last several seconds, if that. For individuals with limited time at their disposal, short-term investments are typically favorable. In certain markets, the short-term nature of an investment may act to mitigate some risks.
Additionally, there are some factors which place short-term investors (in the U.S., at least) at a significant disadvantage over their peers in it for the long haul. Among these factors is capital gains taxes, which is split into short-term (under 1 year) and long-term (over 1 year). The capital gains tax rate for short-term investors is considerably higher than long-term investments, forcing the short-term investor to produce higher pre-tax returns.
Yet even investing prodigies such as Warren Buffet highlight that trying to time the market often results in poor performance. Of course, there are exceptions where frequent traders make incredible returns. However, in the long run the stock market tends to drift upwards together with inflation, providing a good annual return to those who are patient. On top of this, the timing of an investment is a much less important aspect when looking at the big picture. Investors are constantly trying to predict when the next market crash will occur, yet there have been studies which indicate more money is lost worrying about market crashes than in market crashes themselves. Unfortunately, an investor nearing retirement does not have time on their side; being able to stash away their money for decades is no longer reasonable.
With all that said, long-term investing generally has more benefits, as opposed to short-term investing which is inherently at a disadvantage. Despite this, not everyone can take advantage of long-term investing, and some may be forced to take a short-term approach. Investors should be aware of the pros and cons of both types of holding periods and make decisions based on their personal needs. Keeping these key points in mind, investors of all ages should be able to make informed investments which provide them with the best return appropriate for their situations.
Choosing A Broker
Selecting a brokerage firm is a decision that is dependent upon each investor and his/her goals. Historically, there was only one type, a brick-and-mortar broker, but with the advent of the digital age and advanced technologies, discount, online brokers quickly rose to popularity. More recently, innovation has resulted in the emergence of companies like Robinhood, an application and online platform that allows for trading of stocks and exchange traded funds (ETFs) without paying a commission. Well, the discount brokerages weren’t going to sit around and let Robinhood take their business, so as of late 2019, many of the biggest discount brokerages in the industry matched Robinhood’s offerings and decided upon a zero trading commission structure.
To make a decision on which one is best for you, a basic understanding of what each offers will assist in making a choice.
One thing we cannot emphasize enough is taking your time and exploring what brokers have to offer. Don’t rush; that’s one of the fastest ways to “brokeville” in penny stock land. Remember that there is a good reason that penny stocks are trading at the valuation that they are, mostly because they’re highly speculative and many companies could be unproven at this point. Don’t be afraid to “paper trade” and use practice tools that brokers provide to get your feet wet if you’re new to penny stocks. And most importantly, no matter which broker you choose, never, ever put a penny in an account that you can’t afford to watch evaporate before your eyes because penny stocks are high risk plays.
What To Look For When Buying Penny Stocks
- 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.)
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 High/Low 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.
What Is A Day Trading Account & Is It Important When It Comes To Penny Stocks?
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.
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.
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.
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.
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.”
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 VolumeVolume 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 StocksWhile 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 SideWhen 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, EducationI 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.