A stock, also known as an equity, represents the partial ownership of a company. Some companies, known as public companies, allow their stocks to be bought and sold by anyone and everyone on the public markets known as stock markets.
Both individuals and corporations buy stocks as an investment in the hope that the value of the stock will increase over time and yield a healthy return on that investment. Whilst all public companies trade their stocks on the public markets, not all stocks are created equal.
Stocks are placed into different categories depending on a set of predetermined criteria. There are large-cap stocks, also known as “blue-chip stocks”, mid-cap stocks that have a market capitalization of between $1-8 billion, and small-cap stocks, which, as their name implies, have the smallest market value of the three.
This post is going to examine a particularly curious type of stock known as a penny stock. We will discuss what penny stocks are, the risks and costs associated with trading them, and various trading strategies that can be used to profit from these stocks.
NOTE: You can get your free penny stock trading PDF below.
What are Penny Stocks?
Historically, penny stocks were considered to be any stock that traded for less than 1$ per share.
Contrary to what the name might suggest, a penny stock is no longer simply a stock that trades for less than $1. A penny stock is defined by the Securities and Exchange Commission (SEC) in the United States as the stock of any small company that trades at less than $5 per share.
Whilst some penny stocks can be found on major exchanges like the NYSE, most trade over the counter through the OTC Bulletin Board (OTCBB).
It should be noted that a company trading at a share price below $5 does not automatically make them a penny stock. To qualify as a penny stock, the company also needs a small market capitalization (less than $300 million).
Several stocks trade for below $5 but have a significant market capitalization. Genworth Financial (GNW) is an excellent example; they currently trade for $3.90 a share but have a market capitalization of over $2 billion.
Since penny stocks do not typically trade on traditional stock markets, they can suffer from low levels of liquidity, and investors might struggle to find a selling price that accurately reflects the market.
Due to their low liquidity and the small nature of the companies they represent, penny stocks are generally considered highly speculative assets, and investors risk losing significant portions of their principal investment. We will explore the risks associated with penny stocks more thoroughly in the section below.
NOTE: You can get the best free charts and broker for these strategies here.
Are Penny Stocks Risky?
The short answer to this is; yes. Let’s examine some of the reasons why penny stocks can prove themselves to be a high-risk investment.
General Issues
Since most, if not all, penny stocks are relatively small companies, many of them will struggle with the problems of any fledgling enterprise. They will generally be cash poor and suffer from a lack of resources. They may be competing in industries with well-entrenched and highly reputable competitors, and their management teams may be inexperienced or ineffective.
Lack of Information / History
Gauging your risk exposure with penny stocks is also a difficult task. With publicly traded companies, investors can go online and download every financial statement they care to analyze. They are also afforded a wealth of technical data on which they may make decisions and enjoy using numerous online resources to assist their decision-making.
When it comes to penny stocks, this information can prove very difficult to find.
Even when the information is found, it often does not come from a credible source. This is because many penny stocks will trade-off “pink sheets”.
This means that they will not be required to file with the SEC. As a result, these stocks will not receive the same levels of public scrutiny or regulations as stocks represented on major exchanges.
For this reason, investors may consider investing in penny stocks that are represented on the NASDAQ/NYSE or other international exchanges like the LSE/ASX. These penny stocks will have to provide information relating to their financial health and comply with a wide range of regulations.
No Minimum Standards
Stocks represented on the OTCBB and pink sheets do not need to comply with any minimum standard requirements to remain represented on the OTC exchange.
Once a company cannot maintain itself on exchanges like the NYSE, it can move into smaller OTC listing exchanges where there are no minimum standards for listing.
These minimum standards provide a safety net for investors. They ensure that a company will operate in a manner that is in keeping with its legal or regulatory obligations. When a company is not subjected to these minimum standards, investing in them can be especially risky.
Liquidity
As mentioned above, since penny stocks do not trade frequently, they suffer from a lack of liquidity. This means that there is always a chance that an investor would be unable to sell a stock after purchasing it. This would result in an investor needing the lower the price of the share to attract another buyer.
A lack of liquidity also opens up stocks to market manipulation techniques known as pump and dumps. This is a popular and well-known trading scam used to entice new investors to invest in a stock.
In pump and dumps, large amounts of stock with low liquidity are purchased. This forces the price of the stock to skyrocket. Once this happens, the original purchases of the shares begin to sell large amounts of the shares they purchased, crashing the price of the stock and leaving newer investors “holding the bag”, i.e., holding large numbers of shares that have crashed in price.
Should You Invest?
After reading about the risks, you probably wonder why any investor in his right mind would even consider investing in penny stocks? As is usually the case with high-risk investments, the answer to this question is almost always the potential to make money.
Since the companies that trade as penny stocks are so small, the potential upside if they are successful is enormous. Just imagine the potential returns if you had invested $1000 into this strange fruit company called Apple in July 1981 when it was trading for the princely sum of $0.10 a share.
When deciding whether to invest in a penny stock, investors should exercise caution and be wary of any investment they make.
There is no fool-proof strategy for doing this; however, it is recommended that investors pay close attention to a wide variety of factors.
For example, whether or not they have received any SEC trading suspensions, whether they have any large assets but small revenues, have a significant amount of insider ownership, or if their financial statements have any suspicious items in their footnotes that may be cause for alarm.
Penny Stock List
Since penny stocks do not all trade on a single exchange, it can be difficult to find a comprehensive list of all penny stocks as there is currently no central register. You will find several links below to help you locate a list of penny stocks on popular exchanges.
This link will take you to the official stock screener for the Nasdaq exchange. Here you will be able to filter companies by market capitalization. Select companies with a “nano” market capitalization within either the NYSE or the NASDAQ (or both). Any company trading for less than $5 per share is considered a penny stock.
Investors wishing to engage in higher-risk penny stock investing can find a list of penny stocks here. They will be able to filter the penny stocks they wish to find by various markets and the stock price.
If you are looking for international penny stocks, then Yahoo Finance offers a fantastic stock screener that will allow you to scan stocks on the international markets.
For example, in Australia, penny stocks are defined as those with either a $50 million market capitalization or less OR shares that trade at less than $5 per share. You can use the above stock screener to select “Australia” as the region to search the Australian Stock Exchange (ASX). Then, input the correct variables to filter through Australian penny stocks, i.e., small-cap/trade at less than $5 per share.
Penny Stock Costs
With the advent of brokerages like Robinhood and Trading 212 has come the era of free trading.
Many brokerages are now offering investors the ability to trade and invest in the markets commission-free. This is a fantastic opportunity, especially for newer investors who may not have much capital to invest, to begin exposing themselves to the financial markets.
That said, penny stocks are often not commission-free, and at times the cost of investing can be quite high. As we saw in the popular movie “The Wolf of Wall Street”, Jordan Belfort secured up to a 50% commission when selling penny stocks. That was great for Jordan Belfort but not so great for those who invested in the penny stocks he shilled.
Currently, TD Ameritrade has one of the most competitive rates on flat-rate fees for OTCBB trades at just $6.95 per trade. Other brokerages like Interactive Brokers charge a per-share model of $.0035 per share with a maximum of 0.5% of the trade value. To put this into context, if you purchased 20,000 shares at 13$ per share, your total fee would be 13$ (0.5% of the trade value).
While this may not seem like a significant amount, it is considerably more expensive than investing in free trade stocks and can quickly add up with frequent trading.
The Best Penny Stocks to Trade
This section will examine several penny stock metrics that traders should keep an eye out for when trying to identify an opportunity to make money trading penny stocks.
We will then highlight some penny stocks that we believe currently have some trading potential.
Penny stocks can number in the hundreds/thousands, and finding information on them can be difficult. This is particularly true if they trade on the OTCBB markets. When trying to find an opportunity in the market, technical analysis is a trader’s best bet.
Technical analysis will allow traders to skip massive amounts of due diligence. It will also allow traders to identify trading opportunities without knowing anything about the company’s management track record, debt levels, or P/E ratio.
However, due to the low volume typically found in penny stocks, technical analysis can prove to be more challenging when trading penny stocks as low volume can impact the reliability of indicators.
When trading a penny stock using technical analysis, traders should closely examine the following metrics.
Percentage of Shares
Traders should ensure that they seek out penny stocks with a high enough percentage of shares being traded to provide the reliability they need for technical analysis.
For example, if 0.5% of the stock’s total outstanding shares trade on any given day, the technical patterns that form will not be reliable enough to base a trade-off. However, if 10% of shares outstanding are being traded, then chart patterns that form as a consequence will be reliable.
Share Turnover
It would be prudent for traders to calculate how many days it would take at the current trading volume to turn over an amount equivalent to the total shares outstanding if a penny stock with 200 million shares trades a total of 2 million shares a day that equals a total share turnover rate of 100 days.
The smaller that number becomes, the more reliable the underlying pattern will be.
Daily Trading Volume
Traders should also keep an eye on the number of shares that are trading hands every day.
Ideally, hundreds of thousands of shares should be trading every single day. Without this level of volume, the underlying technical analysis would not be reliable enough.
Traders should seek to find penny stocks where the volume of trading is getting higher, as this increases the reliability of the technical indicators they will use to trade.
As we mentioned earlier, trading with technical analysis in penny stocks is quite difficult.
Every stock trades differently, and what works with one penny stock may not work with another. As a result, providing general metrics that constitute enough volume to generate reliable trading patterns is not possible.
Float
Lastly, traders should seek to find stocks that have a float under 100 million shares when trading penny stocks.
If you can find one with less than 50 million shares, then that is fantastic. The lower the float, the easier it is for the price per share to increase, especially when there is a lot of buying interest generated by things like news reports or earnings releases.
This is good news for traders as it provides an opportunity to make significant short-term profits.
Potential Trades
Please note that the information detailed below is current at writing (3rd July 2021). Penny stocks are notoriously volatile, and things can change quickly; please conduct your own due diligence and remember that nothing in this post constitutes financial advice.
No payment was made or received for the mention of the stocks below; neither the writer nor the website has made any financial gain as a result.
Brickell Biotech Inc (BBI)
Our first promising penny stock is Brickell Biotech Inc (BBI). This is a clinical-stage pharmaceutical company that develops treatments for debilitating skin diseases. Their moving averages currently indicate that they are likely to move up in price and point to them being a strong buy.
Prices over the last days of June jumped a healthy 8%. However, if the stock begins to trade down over July, you may need to reconsider this position.
Yamana Gold Inc (AUY)
Our second penny stock is a Canadian company that owns and operates gold, silver, and other precious metal mines in North and South America. It currently has a very promising technical set-up with an RSI of 25.41 and two spinning top candlesticks near the end of June.
These indicators suggest that the stock is highly oversold, and the market may be ready to end the stocks month-long downtrend.
Predictive Oncology Inc (POAI)
Our final penny stock is a healthcare products provider operating mainly in the United States.
It currently trades at $1.21 per share and boasts a market capitalization of $79 million. This penny stock enjoyed a significant 8.65% gap near the end of June due to some extreme trading volume.
This trading volume coupled with strong moving average indicators suggests that investors have a lot of confidence in the trade and a strong move up in the share price is likely.
How to Trade Penny Stocks
#1: Pick a Penny Stock Watchlist
The first step to trading penny stocks will be to assemble a watch list of penny stocks to keep an eye on. You can use the links and characteristics detailed earlier to identify penny stocks you may want to add to your watch list.
#2: Chooser Your Trading or Investing Strategy
There are several strategies that traders can employ to trade penny stocks. As we mentioned earlier, the best penny stocks to trade will be those with high or increasing volume.
Traders who are taking a technical approach to trading penny stocks should pick a strategy that factors in the volume of the stock.
#3: Choose How Much You are Going to Risk
The adage “don’t invest more than you are willing to lose” rings true here.
Penny stocks are extremely volatile, and investors need to be psychologically and financially prepared to see catastrophic losses on their investments. Do not assume that because the price of penny stocks is already low, they are unlikely to fall much further. They most certainly can, and many often will.
#4: Choose Your Broker and Trading Charts
We detailed two brokers earlier in this post when discussing the costs associated with trading penny stocks.
Two alternative brokers which we would recommend are:
Charles Schwab and IG Markets.
There are several chart patterns that traders should familiarise themselves with when trading penny stocks. Here are five of the most common chart patterns that traders should be aware of before they begin trading:
- Bull Flat;
- Double Bottom;
- Golden Cross;
- Fibonacci Retracement;
- Supernova.
#5: Start Making Trades
If you have followed steps 1-4, then congratulations! You are ready to begin trading penny stocks!
General Trading Tips
Here are three tips for investors who are just starting with penny stocks.
- Don’t short a penny stock. It is understandably tempting to short a penny stock that has been significantly pumped up for superficial reasons. Penny stocks are too volatile, and if you are caught on the wrong end of a short trade, your losses could be disastrous.
- When you make a reasonable profit on a penny stock – sell. Traders who make 30% or 40% on a penny stock within a few days may be tempted to hold onto the stock in the hopes of even higher returns. Being greedy is one of the easiest ways to ensure you lose your profits. Take your profits and wait for a new opportunity.
- Disregard tips you find in newsletters. These newsletters are often paid to promote these stocks to create hype and artificially increase the stock price. In the United States, the SEC requires that newsletters include disclaimers at the bottom of these letters to reveal any conflicts of interest. Keep an eye out for these.
Lastly
The temptation to trade penny stocks is easily understood; they are cheap and can generate massive profits. That said, trading penny stocks is highly risky and can potentially cause substantial losses if traders are not cautious.
When it comes to trading or investing, regardless of whether it is cryptocurrencies or penny stocks, traders should stick to the general rule: don’t trade what you don’t understand.
If you decide to get started with penny stocks, be sure to do your research and know the risks.
NOTE: You can get your free penny stock trading PDF below.
Dylan is both a trained lawyer and an experienced financial content writer from the United Kingdom . He specializes in writing about the US markets and has developed a keen interest in cryptocurrencies and decentralized finance.