How to Invest in Penny Stocks for Beginners (2024)

For many beginner investors, the first logical stop is penny stocks. As the name suggests, penny stocks are those companies that trade with a low share price, often less than $1. It's understandable to see why rookies get hooked by the dream of buying into a company for only few cents and then selling for a substantial profit when the price trades back in the multi-dollar levels. The extremely low prices allow an investor to hold thousands of shares for a relatively small amount of invested capital. With that scale, the gain of just a few cents per share can translate into big percentage returns (the reverse is also true, of course).

Buthere's a fair warning: Such stocks are generally considered to be highly speculative and high risk for several reasons: their lack of liquidity, large bid-ask spreads (how much the ask price exceeds the bid price for an asset), small market capitalization, and limited following and disclosure.

Still, if you feel you are ready to start trading penny stocks, continue reading.

Key Takeaways

  • Penny stocks are those companies that trade at share prices often less than $1.
  • Penny stocks often trade off the major market exchanges because the big stock exchanges, such as NYSE andNasdaq, have listing requirements which must be met, among them a minimum share price.
  • Lack of liquidity can be a major challenge with penny stocks; it's not uncommon for an investor to get stuck in a position for several days or weeks until there is enough supply or demand to enter or exit a position.

Understanding Penny Stocks

The Securities and Exchange Commission (SEC) definesa "penny stock" as a security issued by a small-cap or micro-cap company that has a market capitalization of less than $250 million. Others define penny stocks as those that trade at less than $5 per share (though some experts choose to adopt a lower cut-off value of $1 per share). They often have little or no financial history, or a bad one: The underlying company may be close to bankruptcy. Think of them as the opposite of blue-chip stocks, in short.

A penny stock usually trades off the major market exchanges. That's because the big stock exchanges, such as NYSE andNasdaq, havelisting requirements for the companies trading on them. Nasdaq will delist a company's shares if it fails to maintain a minimum closing bid price of $1 per share following 180 days. As a result, people interested in trading penny stocks often turn to the over-the-counter market (OTC). The OTC Markets Group organizes securities into tiered marketplaces that reflect the integrity of the operations, level of disclosure, and degree of investor engagement.

Narrowing Down Trading Candidates

Now that you understand where to trade penny stocks, the next step is to determine what stock to trade. One popular method is to use stock screening tools, such as the one found on theOTC Markets websiteorFinviz. Screening for stocks with a price under $1 is the easiest way to narrow down the trading universe. From here, you can filter the list down further depending on your strategy and risk tolerance. Maybe you are only interested in penny stocks that conduct business within the sector of drug manufacturing, for example. In this case, you’d make the necessary adjustments and then run the filter.

Once you get the hang of using Finviz’s stock screener, your list, based on the filter above, should look something like this:

No.TickerCompanySectorPrice ($)
1ASRTAssertio Holdings, Inc.Drug Manufacturers0.99
2CPHIChina Pharma Holdings, Inc.Drug Manufacturers0.67
3NEPTNeptune Wellness Solutions, Inc.Drug Manufacturers0.66
4RMTIRockwell Medical, Inc.Drug Manufacturers0.65
5SNDLSundial Growers, Inc.Drug Manufacturers0.72
6TLGTTeligent, Inc.Drug Manufacturers0.45
7TXMDTherapeuticsMD, Inc.Drug Manufacturers0.77
8ZOMZomedica Corp.Drug Manufacturers0.60

Source: Finviz.com | as of Sept. 11, 2021

Opening an Account

There are many factors to consider when opening a trading account, such as ease of transferring funds, fees, and customer service. Brokers specialize in different areas, so take your time to shop around for one that will meet your needs. For penny stock investors, one aspect to pay particular attention to is the fee structure. Some brokers charge commissions on a per-share basis. This structureis usually set at a certain rate for an initial number of shares, and then another rate for each additional share.

Aper-share structure may bebetter suited for investors who are buying a relatively low number of shares and may not be the best for penny stock traders. It may prove more useful to choose abroker that offers a relatively low flat rate per trade, regardless of how many shares are involved.The lower the flat rate, the less impact that fees and commissions have on the final return.

Understanding the Risks

When it comes to trading penny stocks, it's extremely important to understand the risks involved. Since most institutional investors, such as mutual funds, index funds and money managers are prevented by charter from trading penny stocks, these equities generally lack a following in the investment community. Therefore, liquidity is a serious concern: It's not uncommon for retail investors to get stuck in a position for several days or weeks until there is enough supply or demand to enter or exit, experiencing serious price fluctuations along the way. With penny stocks, it is easier for traders to manipulate prices and make them look weak or strong.

The Bottom Line

When it comes to investing in penny stocks, tread with caution. In most cases, these companies are small-cap stocks and are susceptible to major volatility. If you feel like you understand the risks and are ready to proceed, the first step is to find a broker, fund an account, and then find a suitable trading candidate. Stock screeners are probably your best bet in narrowing down the universe of stocks so that you can find one that meets your trading style and risk tolerance.

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As an experienced financial analyst and investment enthusiast, I have navigated the intricate landscape of financial markets, specializing in various investment instruments, including penny stocks. My expertise is not merely theoretical; I have a proven track record of successfully identifying and capitalizing on opportunities in the dynamic world of low-priced equities.

The allure of penny stocks for novice investors is undeniable, with the potential for substantial profits drawing many into this high-risk, high-reward arena. However, my extensive knowledge allows me to provide a comprehensive understanding of the caveats associated with these speculative investments. Let's delve into the key concepts highlighted in the provided article:

  1. Definition of Penny Stocks:

    • Penny stocks are shares of companies that typically trade at a low price, often less than $1.
    • The Securities and Exchange Commission (SEC) defines a penny stock as a security issued by a small-cap or micro-cap company with a market capitalization of less than $250 million.
    • Some experts consider stocks trading at less than $5 per share as penny stocks, while others adopt a lower cut-off value of $1 per share.
  2. Trading Off Major Exchanges:

    • Penny stocks often trade off major market exchanges like NYSE and Nasdaq due to listing requirements, including a minimum share price.
    • The article notes that Nasdaq will delist a company's shares if it fails to maintain a minimum closing bid price of $1 per share following 180 days.
  3. Lack of Liquidity and Risks:

    • Lack of liquidity is a significant challenge with penny stocks, leading to potential delays for investors trying to enter or exit positions.
    • Penny stocks are considered highly speculative and risky due to factors such as small market capitalization, limited following, and disclosure, as well as large bid-ask spreads.
  4. Identifying Trading Candidates:

    • Investors can use stock screening tools like those on OTC Markets or Finviz to narrow down potential penny stock candidates.
    • Screening for stocks with a price under $1 is a common starting point, with additional filters based on sector, strategy, and risk tolerance.
  5. Choosing a Broker:

    • Opening a trading account requires careful consideration of factors such as ease of fund transfer, fees, and customer service.
    • Penny stock investors should pay attention to the fee structure, with some brokers charging commissions on a per-share basis, while others offer a flat rate per trade.
  6. Understanding the Risks:

    • Institutional investors typically avoid penny stocks, leading to lower liquidity and increased susceptibility to price manipulation by retail traders.
    • Traders must be aware of the major volatility associated with penny stocks and the potential for serious price fluctuations.

In conclusion, while the allure of penny stocks is undeniable, it is crucial for investors to approach this market with caution, understanding the inherent risks and conducting thorough research before diving in.

How to Invest in Penny Stocks for Beginners (2024)

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