Penny stocks have always made investors a little wary. While they have read many success stories and stories of losses worth millions, it’s difficult to filter out which of these stories are true and which are just exaggerated articles and rumors to trick you.
Penny stocks are not more profitable. Certainly not as much as those found on official stock exchanges such as the NYSE or NASDAQ. Profits with penny stocks do exist, but mostly for brokers. While exceptions are always there, novice traders trading penny stocks will lose more often than they win.
In this article, you will learn what penny stocks are, the different types of penny stocks, and an overall rundown of why they have been shunned to electronic listings. In the end, you will also learn a few tips to help you with making a profit on 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?
If you have heard about penny stocks only recently, here is the full story. Penny stocks are classified as shares traded by small companies, start-up companies, and firms close to bankruptcy. The U.S. Securities Exchange Commission defines penny stocks as all stocks below $5. In the United Kingdom, penny stocks are usually priced under £1.
Either way, when you come across a penny stock, you will know because rarely do they reach the $5 mark and instead stay in the range of $0.20-$3. These stocks also have very low liquidity, which does not prove profitable for an investor looking to sell and buy multiple stocks daily. There are simply not enough buyers or sellers in the market for penny stocks, at least not legitimate ones.
Another thing you should know about penny stocks is that you will not find them on your usual New York Stock Exchange or the NASDAQ. Penny stocks are priced so low because the firms that issue them do not meet the exchange requirements, suppose a firm wants to trade on NASDAQ or the NYSE.
In that case, they need to regularly submit financial records of multiple years, at least five or six, meet a specific market capitalization requirement, and have a clean background history. In other words, the firm should be one that can promise profits and is not involved in any scams that would threaten the investor and make him lose money.
The firms that issue penny stocks do not meet these requirements. While you may find a few penny stocks on such large stock exchanges, most of them are traded over-the-counter through the OTC Bulletin Board (OTCBB), private OTC groups such as the OTC market, and on Pink Sheets. All of these ‘markets’ are not really markets. Their prices are quoted electronically, meaning there is no trading floor.
Moreover, because these firms have very low liquidity and no official requirements to meet, you may not even have enough information to base your decisions. The OTCBB is still somewhat regulated by the Financial Industry Regulatory Authority, so the companies listed must meet some standards. The problem with the rest of the electronic trading markets is that they pose a big question mark.
Penny Stock Levels
Having an accurate financial history for a company is one thing. It is more dangerous when the price quoted to you is manipulated. There are four different penny stock levels; this will help you roughly classify which ones are good and which ones you should avoid.
- Level 1: These stocks can be found on the NASDAQ or the NYSE. They are less open to manipulation and have a higher price than the average range of a penny stock. Some of them may even be higher than $4. This is because they are subject to higher standards of providing financial results, a transparent report on profits, and business practices.
- Level 2: These penny stocks are found on OTC markets. They usually fall below $2, sometimes even going to 99 cents per share.
- Level 3: Also known as sub-penny stocks, these fall below one penny per share. These shares could not cut the large stock markets, not having enough profits to even sell at a penny per share. These stocks will never make it to the NYSE unless a drastic increase in revenue and capitalization is seen.
- Level 4: The lowest of them all; these stocks are known as the triple zero stocks. They are priced between 0.0001 and 0.0009 cents a share.
Problems With Penny Stocks
In case it is not apparent yet, penny stocks have a lot of downsides to them. Most of the time, you will have a bad experience or bear losses larger than the profits you made. A lot of the time, you may find yourself with worthless stocks because prices fell too low and there are no buyers to sell to. Listed below are two of the most prominent problems that you should be mindful of when trading Penny Stocks.
Volatility
Penny stocks are highly volatile, meaning they fluctuate even from the tiniest of transactions. Investors willing to stock up on these are generally rare to find, and those that you will find will be beginners hoping to achieve some level of return on low investment. The prices of penny stocks are easily moved up or down in a day by large gaps even though only a few transactions may have occurred.
While volatility is useful if you are there at the right time or place, penny stock prices are often subject to pump and dump scams meaning these prices may be manipulated. The lack of buyers brings us to our second point; low liquidity. Even if you buy penny stocks at a low price hoping to sell them for a profit, it won’t be easy to find investors that are willing to buy these stocks from you at the desired price.
Scams
The penny stock market is also where most scammers exist. Schemes such as the pump and dump or short and distort are found easily. Scammers will buy or borrow stocks from brokers and manipulate their prices by creating rumors of profits and promises of return.
Once the prices begin to rise, they will sell these stocks, ‘dumping’ them and keeping the profit for themselves. It is essential to keep a lookout for these practices or stay ahead enough to maneuver through them.
Can I Make a Profit With Penny Stocks?
Technically, yes. If you invest in a penny stock worth $1 and sell it for $2, you will be making a 100% return. However, prices are often manipulated, and your profits may not be from reliable companies. However, profits with penny stocks do exist, keeping in mind a few things:
- Keep an eye on earnings. Do not just rush into buying a penny stock because you monitor the price for a week. Monitor and target those that show steady growth in earning and trade near to their week high.
- Steer clear of promotional advertising. Guru schemes may trick you into investing in penny stocks. Advertising methods like such use exaggerated language that exists on the surface. Plus, the sources of these advertisements may not be reliable either.
- Consider the trading volume. Penny stocks are reliable if they are traded in huge volumes. Try to go for those that trade more than 100,000 shares per session.
Author’s Recommendations: Top Trading and Investment Resources To Consider
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Conclusion
Penny stocks have a lot of problems; volatility, scammers, lack of information. But they exist because it is possible to make a profit on them. Keep in mind to stay quick on your feet and recognize scammers. You can alternatively try to become a broker and make substantial sums of money pushing penny stocks. Either way, as long as you’re willing to be cautious and smart, you can make money in penny stocks.
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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