Penny stocks have a very polarizing existence in the public sphere. Some traders swear by them, while most avoid them altogether; that is because different trading strategies work for penny stocks compared to blue-chip stocks. A novice day trader might wonder whether day-trading works in this niche.
Penny stocks are ideal for day trading because when significant profit is made trading penny stocks, the price hikes are temporary, and holding a position for multiple days might be risky. To make money day trading penny stocks, you must be highly strategic and know what you’re doing.
This article goes over what penny stocks are and the inherent advantages and disadvantages they pose. Furthermore, you’ll learn about day trading and what you must know before committing to this style of investing. Finally, you will find out how day trading can go hand in hand with penny stocks.
IMPORTANT SIDENOTE: I surveyed 1500+ traders to understand how social trading impacted their trading outcomes. The results shocked my belief system! Read my latest article: ‘Exploring Social Trading: Community, Profit, and Collaboration’ for my in-depth findings through the data collected from this survey!
Table of Contents
What Are Penny Stocks?
The term penny stocks became popular with the mainstream exposure provided by the movie Wolf of Wallstreet. Unfortunately, this wasn’t positive exposure as the protagonist Jordan Belfort was positioning penny stocks as much more valuable than they were. His actions led to many people losing their money and wiping their entire retirement savings. That led to negative connotations with the term.
Penny stocks – when you remove the emotion – are just stocks that cost less than a dollar (and sometimes stocks that cost less than five dollars). These stocks, just like regular stocks, can be traded for profit. However, they’re not immediately liquid, and one should avoid taking large positions without a strategy. Penny stocks cost so little because the business has a smaller valuation or the shares are diluted a lot more for the company’s capitalization.
Regardless of the reasons for a stock to qualify as a penny stock, the niche’s advantages and disadvantages apply (albeit not equally) to all penny stocks. They’re all less liquid than a stock like Coca Cola. They’re all cheaper to buy than Tesla. And they’re all subject to much more price manipulation than the average stock.
Pros of Penny Stocks
When you trade penny stocks, you have certain benefits:
- Low barrier to entry – You do not need to have $25,000 in your account to start trading penny stocks. With minimal risk, you can get experience, which you can later translate to the broader market.
- Smaller losses – Unless you put all your investable cash in the same stock, you are less likely to lose a lot of money in penny stocks. On the other hand, you might find yourself losing $50 to $150 if a standard stock you’re holding takes a dip.
- Greater opportunity – While penny stocks are mostly illiquid, knowing what you’re doing can help you make much more money than the broader market. By understanding how the price of penny stocks is manipulated, you can purchase the stocks that are being pumped. The trick is to avoid holding these positions for too long.
Cons of Penny Stocks
Penny stocks come with some massive drawbacks that you need to watch out for:
- Hard to sell – Penny stocks are mostly illiquid because their inherent risk makes most investors wary of purchasing even the smallest amounts of penny stocks.
- Easy to over purchase – Penny stocks attract novice investors, and because of contrast bias, many of them tend to compare their prices to an anchor price set by blue-chip stocks. This comparison is false and may influence most beginners to buy large quantities of useless stock just because they think they’re buying a bargain.
What Is Day Trading?
With the boom of ‘make money online’ schemes, one of the most popularized forms of online income is day trading. Mostly backed by gurus selling day trading courses, this craze has made day trading a semi-mythical stream of side-income gold.
Here’s the reality: Day trading is merely understanding risk and managing it daily to make a short-term profit. Most day-traders lose money because they trade with emotion instead of strategy. Because strategy dictates success, there is no need to limit yourself to selling a stock within the day.
A day trader spends the day trading for profit, but he doesn’t necessarily sell off the stock he has bought by the end of the day. Clarifying this misconception is vital to your understanding of how day trading penny stocks differ from day trading blue-chip stocks. But before we get to that, let’s cover some advantages and disadvantages of day trading.
Pros of Day Trading
As a day trader, you’ll have the following perks:
- Ability to make money in the short-term – While most investors are in the long-term game, day-traders hold a position exclusively to make a short-term profit. This allows them to get significantly higher returns (in the short-to-medium-term) than a passive investor.
- More experience in a shorter time – Another critical aspect of day trading is having a higher trading frequency. A long-term investor might make one right decision and stick to it for years. This doesn’t give him experience in trading but only gives him experience in holding a position. A day trader can easily make over fifteen hundred trades in a year. Thus, a day-trader has more experience in analyzing stocks than an average investor.
Cons of Day Trading
Just like with anything, day-trading comes with its own set of drawbacks:
- Higher risk – Just like the road with the most traffic has the highest number of accidents, the kind of trading that involves over three transactions a day will have a higher risk of making bad trades. You can offset this by making profitable trades that cover your bad ones’ losses and result in a net profit.
- Commission and fees – Because brokers charge for their services by the transaction, the more transactions you make, the higher fee you pay. As a result, you must make your transactions profitable enough to net you a profit after covering the commission and fees.
Penny Stocks and Day Trading – Do They Go Hand in Hand?
Now that you know penny stocks as the low-price and low-value stock that can be easily manipulated by big players and you understand day trading as high-frequency trading, let’s explore how the two go hand in hand.
First of all, a day trader can hold a stock like Facebook for a whole week, but the same day trader would be wise to sell a penny stock that is rising in value before the day ends. That’s because penny stocks rarely experience a long enough bull run.
Day trading is ideal for penny stocks precisely because the profits are to be made in that small of a time-frame and that low of a margin. However, the drawback of day trading (commission) is maximized with penny stocks because of brokers’ prices.
You can get optimal results by relying on Robinhood and similar platforms to avoid broker fees. Surprisingly, you can invest in penny stocks on Robinhood because there are substantial quantities of penny stocks listed on NASDAQ and similar exchanges.
By limiting yourself to penny stocks on NYSE and NASDAQ, you’re getting yourself a class of low-priced stocks that are comparatively more liquid and that you can purchase without paying a large commission.
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Conclusion
Penny stocks may have developed a bad reputation because of the way scammers used them in the past. But if you arm yourself with the knowledge and set the right strategy, you can start making money day-trading penny stocks. It is advisable to make your trades in small quantities and deal exclusively with stocks that are on NYSE and NASDAQ.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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