What Is A Penny Stock — Definition & More

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A penny stock is the stock of a company that trades for less than $5 per share. While these are generally assumed to be shares of smaller companies, plenty have market capitalizations in the billions of dollars. There’s also a general assumption that penny stocks are only traded on lesser-known exchanges like the Over-The-Counter (OTC) exchange or pink sheets. However, there are plenty of penny stocks trading on the Nasdaq and New York Stock Exchange.

Why Trade Penny Stocks?

Now that we know the definition of penny stocks let’s discuss some of the reasons why people might trade or invest in them. First, I assume readers are new to this topic and should have a general understanding before jumping into these volatile waters. Different people trade penny stocks for various reasons. Some look for investment opportunities at the “ground floor” of corporate growth. Meanwhile, others trade penny stocks looking to capitalize on quick bouts of volatility in the stock market.

Case in point, a person with $1,000 in a trading account, can purchase 1,000 shares of a stock trading at $1. If the share price rises 10 cents, the trader has just gained 10% on their investment. Similarly, if that same person took the $1,000 and purchased shares of Apple ( NASDAQ: AAPL), they would not only have just a few shares in their possession, but a 10-cent move wouldn’t mean much for their bottom line.

There are also extreme cases where penny stocks can explode hundreds of percentage points within a single session. Since they’re generally less liquid and have smaller market capitalizations, bouts of irregular buying have been known to trigger massive breakouts. It’s the 100% and even 1,000% moves that have become so enticing. Are there instances where higher-priced stocks jump 50% in a single day? Yes, but the frequency of 100%+ moves in penny stocks is by far much higher than any other type of stock. At the end of the day, people trade penny stocks to make money and leverage smaller sums or lower prices to achieve exponential gains.

Are Penny Stocks Good For Beginners?

We answered this question in more detail in the article “ Are Penny Stocks Good For Beginners? [Answered].” Generally speaking, penny stocks are good for beginners as long as you know what you’re doing. Like all investments, penny stocks carry plenty of risks. We discussed the opportunities for traders and investors to make money with these lower-priced shares. But they can also lose money in a similar fashion. This lends itself to a gambling mentality for newer traders. “If I just Bet $200 to Make $400, Then I’ll Buy Penny Stocks.”

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I’m sure this thought has crossed your mind if you’re new to trading. The reality is that this isn’t a casino, and there are ways to consistently make money with penny stock without treating it like you’re betting on red or black. The first step is putting together your list of penny stocks. To do that, researching and conducting due diligence is your primary focus.

Whether it’s finding penny stocks with high volume, identifying penny stocks with unusual options activity, finding insider trading data, or picking penny stocks with news, a catalyst is something most traders will seek out first. From there, you can condense your list of penny stocks based on other factors specific to your trading style or investment strategy.

Can You Get Rich Off Penny Stocks?

Yes, you can get rich off of penny stocks. This is another great question that beginner traders ask. Like many investments, “getting rich” may be a goal. But it’s developing the right strategy and using the proper investment tools to get to that goal. Since penny stocks are cheap, the thought is that getting rich can be accomplished in a short period. The problem is that unless you can remove emotion from trading, it’s easier said than done.

Understanding your risk tolerance, planning your trades, and using a real strategy is essential. Getting rich is a great goal but becoming consistently profitable first is a big step you’ll need to take. Being comfortable with “base hits” will help you reach your goals. There will, of course, be massive home run trades that penny stocks are known for. But considering the average market return is 10%, a 20% gain with penny stocks is a market-beating trade. Stay grounded, hone your skills, and learn the correct way to trade and invest in stocks.

Should You Invest In Penny Stocks?

Investing in penny stocks can be a difficult task. Since they are so volatile, the value of a position in stocks under $5 can change drastically. In the long run, investing in penny stocks is generally a risky decision because many of these companies are in start-up phases and known to fail more than they succeed. Does this mean that all penny stocks aren’t worth investing in?

No, and there are plenty of examples of penny stocks that hit it big. Companies like AMC Entertainment ( NYSE: AMC), GameStop ( NYSE: GME), Novavax ( NASDAQ: NVAX), Nio Inc. ( NYSE: NIO), and many others made the move from under $5 to highs in the hundreds of dollars at times. For those who could stomach daily, weekly, or monthly price swings of 20%-50% or more in either direction, their anxiety paid off handsomely.

Can You Buy Penny Stocks In An IRA? The Answer May Surprise You

Then again, there are just as many if not more penny stocks that ultimately fell apart. That left countless investors holding big bags and, in many cases, becoming entirely disenchanted with penny stocks or the stock market in general. The point is to make sure you know how to trade and invest, know what you’re looking at, and understand why you’re putting your hard-earned money into something. Should you invest in penny stocks? The answer to that heavily depends on your strategy and the company’s true potential.

How To Buy Penny Stocks

When buying penny stocks, most traders and investors will determine how much money they’re willing to part with. Said another way, how much could you lose without it impacting your daily life? Since there is still risk involved, it isn’t uncommon for penny stocks to lose 50% or more of their value in a very short period. If you’re new to trading, you may not have the proper skills to know that taking a 10% loss now will save you from a 40% loss later on because you held onto a position you “hoped” would rebound.

You’ll also want to understand the trading fees involved. Since many new traders will begin with smaller accounts, they’ll likely make smaller monetary gains. If your winning trade nets you $20 but your fees are $14 for placing a buy and sell, you’re left with $6, and remember, you’ve also got to pay taxes on that money. Thanks to companies like Robinhood Markets ( NASDAQ: HOOD), Webull, and others, there is plenty of low commission and no commission options when it comes to brokerage services.

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You’ll also want to understand any limitations of your broker. Robinhood, for example, restricts access to OTC penny stocks. Even though you can buy cryptocurrencies like Shiba Inu for fractions of a penny, their stance on penny stocks trading under $0.01 is strict. In this example, if you want to buy OTC penny stocks, platforms like Robinhood may not be your best option.

Final Thoughts On Penny Stocks

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Originally published at https://pennystocks.com on May 17, 2022.