Penny Stocks 101

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Penny stock trading is a game that can either cost a trader big time, or generate huge profits in a short amount of time. It’s about hopping on the bandwagon of swift penny stock movement, and capitaling when you stand to make the most. 

What are penny stocks?

The most basic definition of a penny stock is that it’s a stock that costs $5 or less per share. 

Stocks are issued when a public company wants to raise funds to finance themselves without coming up with the money themselves like a private company would. These companies would issue shares that the public can buy, which means that the shareholder owns a percentage of that company. All stocks that cost $5 or less are considered to be penny stocks, but sometimes there’s foul play behind the scenes which can either make or break traders.

Penny companies often pay promoters to advertise them as the next best thing, as this generates a large amount of interest in the company, even if the company isn’t actually succeeding or developing product at this time, the influx of people buying shares increases the price per share. When the promoters stop advertising the company the interest drops, and the price per share comes back down with it. 

Penny stock companies usually don’t follow SEC guidelines of being transparent with the public about their finances. This is to cover up the fact that they might not be as successful as the promotion has made them appear to be. Quite often, penny stocks are a part of pump and dump schemes. Pump and dump means that the price of the stocks rises due to the promotion resulting in a large uptake of shares. The promoters and company insiders will ride the wave and jump ship when it benefits them the most and they walk away with large amount of profits, the price then drops and many traders lose out in the downfall. This is where short stocking comes in. A trader who can see that this is a pump and dump scheme will opt in and out of the company shares when they stand to make the most from it. 

Why Trade Penny Stocks?

With the risk surrounding penny stocks, you might find yourself asking why do traders get involved with penny stocks when they have other trading options.

Pennys stocks can sometimes be pump and dump schemes, or start-ups without a future, but sometimes, investing in the underdog pays off if the company continues to grow. Should a company that once sold shares at penny stock prices succeed, the payoff for the shareholder can be massive.

However, in pump or dump cases, investing in a penny stock is a quick way for a trader to make big profits without staying in the game too long.

How to Trade Penny Stocks?

Open up a margin account:

Most of the time, traders are betting that the share price will increase and they can make a profit by selling their shares for a higher price than what they bought it for. This is called going long. However, short selling is the opposite. When a trader is short selling, they’re betting against the company. This means that they anticipate that the share price will decrease. In this case, a seller opens up a margin account and borrows shares, and then buy the shares back when the price falls.

Familiarise yourself with the market:

As knowledgeable as you may be with Wall Street (NYSE), or the American Stock Exchange (AMEX), penny stocks are not visible on these exchanges. To find penny stocks, it’s worth looking at the OTC Bulletin Board (OTCBB) which is an electronic trading exchange for companies who are not listed with the NASDAQ. It’s seldom that these stocks trade for more than $5 and are somewhat liquid and volatile. The NASDAQ Smallcap Market should also be looked at as their stocks trade between $1 to $10. The pink or grey street exchanges often have stocks for under $5 but due to the fact that they’re not liquid, they aren’t ideal for pennystocking. 

Wait until you’re ready

If you want to avoid getting burnt by a pump and dump, it’s worth practicing paper trading on platforms such as StockstoTrade, which is a simulation of the stock market. It’s also possible to talk to other traders on Profit.ly, and learn from them. Regardless of how the trade works out, if you’ve borrowed stock to short sell, the broker needs to be paid back.

Don’t take anything at face value

As promoters are paid to hype up the company, it’s smart to assume that their suggestions should be taken with a grain of salt, but these aren’t the only people to be skeptical of. As penny stocks are usually small businesses they’re not going to disclose SEC finances because they want to hide their shortcomings, as up to 70% of startups’ fail within the first year. Traders should be wary of Penny Stock Pickers who promise huge payouts for traders. Unless a trader plans on investing in the company they’re suggesting, to capitalise on the pump and dump, their advice shouldn’t be taken on board, this is where new traders lose money. There is a lot to learn on How to Trade Penny Stocks.

How to make the most out of Penny Stocks

Play it safe:

Don’t risk a large amount of your capital in one venture, as the losses can be astronomical. A good rule of thumb is to avoid holding more than 50% of the business’s daily shares traded. Furthermore, cut your winnings and losses quickly. The market moves fast which means you should cut your loss if the market doesn’t move in the direction you hoped immediately, rather than holding out and hoping it will turn back around. The same applies for winnings. When you go long you try to ride the high to sell for the highest price, but pennystocks are so volatile that you need to get in and out as quickly as possible. 

Be adaptable:

Being able to trade both long and short is a valuable skill to have, it means that no matter what’s happening in the market you can continue to trade and make money. This also requires being open to trading with almost any type of company. As the dream company might never come along, traders should be open to any opportunity they think they can profit from.