Trading 101: Penny Stocks

Why trade penny stocks? They’re cheap! To meet the criteria of being a penny stock, they have to be listed at less than $5, meaning you don’t need a lot of capital to start investing. The potential for large returns also makes penny stocks attractive to investors. 

What are Penny Stocks?

A penny stock is a stock of a small company that trades for < $5 per share, as defined by the Securities Exchange Commission (SEC). These companies are typically relatively new so don’t have a long performance record and have a small market capitalisation making them speculative investments. Most penny stocks are not always available on large exchanges like the New York Stock Exchange (NYSE), so are mainly traded via over-the-counter (OTC) transactions. 

As penny stocks are tied to small companies and are traded less frequently than most stocks they have a lack of liquidity as there is less demand for them in the markets. This means prices may not accurately reflect the market, a similar issue that some alternative investments find. Their lack of liquidity means penny stocks are considered highly speculative. Being highly speculative means both there is a high potential for profit but also a high risk of losing money with this type of investment. 

As there is a higher risk associated with penny stocks than typical stocks it is advised that you set a stop-loss order and fully understand the price you want to enter and exit the trade at. Penny stocks are high-risk investments, so while it is possible to benefit from explosive gains there is also the potential for you to lose money. 

Penny stocks are provided by small businesses as a way to get funding, usually for companies just starting out. They sell stocks at low prices and at a much lower quantity than typical stocks or blue-chip stocks. Blue-chip companies are typically well-established and financially sound as opposed to small companies that come with high financial risk. 

There are  a few reasons why penny stocks are risky:

  • Private records mean the public have a lack of information to use to consider buying penny stocks. Unlike blue-chip stocks, penny stocks are not required to file financial statements with the SEC – who regulate markets. 
  • No minimum standards means penny stocks can be listed on OTC exchanges no matter their performance. Needless to say this makes investing in penny stocks risky. 
  • Low liquidity is inherent to penny stocks as they are not traded frequently. This opens up the opportunity of fraud as traders can manipulate prices in a pump and dump. 

OTC Penny Stocks v major exchange Penny Stocks

Some penny stocks are listed on major market exchanges if they are large, but based on market capitalisation trade at < $5 per share.

Ever heard of Pink Sheets? These are the cheapest of all publicly traded stocks and are traded on the OTC market. The OTC market does not require them to comply with the safety measures and regulations that stocks listed on large echanges such as NYSE or NASDAQ require. To trade on these larger exchanges the company must present their financial history and their stock must consistently trade at above $1 per share. A company unwilling to be transparent about their finances raises a huge red flag, therefore it may be best to avoid trading OTC penny stocks. Trading on OTC markets not only has a lack of regulation but also typically has stocks with less liquidity, making them more dangerous to trade. 

We pose that investing in penny stocks listed on larger exchanges will reduce your risk a little. Penny stocks listed on larger exchanges are cheap but still provide the high potential for gains without the risk of fraud or bankruptcy. 

How to choose the best Penny Stocks?

You are fundamentally looking to invest in penny stocks that are likely to make big moves.

To find specific stocks to trade you can look for certain criteria: 

  • News presence that will likely catalyse the stock. This can be anything from earnings reports to the release of a new product.
  • Float volume under 100 million shares as this means the stock price is more open to buying pressure that can push the shares up quickly.
  • High relative volume so you know you can get rid of the stock if you want. Check pre-market volumes to ensure you have plenty of liquidity.

Before you invest in penny stocks, you will need to open an account with a broker to manage your investments. 

Choosing the best online stock broker can make the difference from an easy and exciting new experience to  constant frustration and disappointment. Accessing financial markets through online brokers is easy and inexpensive but there are so many out there tailored to a different sort of customer so choose the right broker that will optimise your user experience and profits. 

If you’re just starting out we recommend eToro and easyMarkets for their easy to use interfaces and fee – free trading.

Top Penny Stocks

Zomedica (ZOM) are in the veterinary industry and have developed a product called Truforma which has gained a lot of interest. The stock will pick up speed accordingly so get in there quick. Currently trading at $1.90 per share.

Cerebain Biotech (CBBT) develops ground-breaking treatments for Alzheimers, a condition that is becoming more and more prevalent. They have an upcoming merger with PKG which will likely push the stock high. Currently trading at $0.20 per share.

ToughBuilt Industries, Inc. (TBLT) have been rising fast with sales increasing 30% over just five years. After a recent rise, we may see a dip soon – presenting a good opportunity to buy. Currently trading at $1.50 per share.

Gold Resource Corporation (GORO) works in gold and silver production. Due to recent uncertainty with the gold market, this penny stock is an absolute bargain at just $3.00 per share. With commodity prices set to rise over 2021, this may be a great opportunity for profit compared to larger gold companies on the market. 

Arcadia Biosciences, Inc. (RKDA) manufactures and sells agricultural chemicals and technologies. Stock prices dropped sharply after a direct offering scared investors into a sell-off with fears that the company may be on the brink of dilution. If the stock rises past $3.50 (currently at $3.20) then the rise should continue through 2021.

Now you know that penny stocks can get you high potential gains but high potential losses. Will you be investing? We recommend eToro and easyMarkets for beginners. 

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