How to Buy Penny Stocks: A Beginner's Guide
Penny stocks might sound like something to play with if you want to dabble in trading without investing too much, but they’re actually better suited to people who have higher risk tolerance. If you're interested in them, you first need to know how to find and buy stocks in general before learning how to buy penny stocks.
Definition of Penny Stocks
Fortunately, penny stocks (or micro-cap stocks) are not too difficult to understand. They are essentially stocks from companies trading for a share price under $5. Some of these shares can cost just pennies - hence the name - and many people sell and invest in them.
You may wonder why they’re so risky if they’re so cheap: First of all, penny stocks can be traded on a regular stock exchange, but that is rarely the case. Instead, they’re usually bought and sold in over-the-counter transactions. What’s more, they are infrequently traded, because they belong to small companies, which makes them very difficult to sell.
As a result, they’re considered very speculative, as you’re buying something very cheap, that you can’t always trade, in the hope that it will someday rise in value enough to be traded regularly.
Why Trade in Penny Stocks
With such a high level of speculation attached to buying penny stocks, you might wonder whether they’re worth it. What are the benefits of investing in them or trading them, and is it the right choice for you? Well, just like any other stock, penny stocks have the potential to give you excellent returns:
One of the benefits of penny stocks is just how many options they give you. You have a vast market of companies to choose from, many of which are largely overlooked, and therefore cheap, but could one day end up being great choices. On the flip side, most penny stocks won't increase in value in any significant way.
Trading vs. Investing
If you're looking into how to buy penny stocks, you could consider trading them or investing in them for a longer period. Each of these options can give you different benefits, as well as various drawbacks.
Investing in Penny Stocks
If you decide to invest in penny stocks, this will make you a shareholder, with all of the rights and responsibilities that come with it. You will have voting rights and receive dividend payments, and you'll have to pay the total amount of your investment right away. If you want to make a profit, you'll have to do so by selling your shares for more than you bought them.
Trading Penny Stocks
Trading penny stocks allows you to buy and sell them quickly. For many people, this is the best way to deal with penny stocks. Most penny stock traders make their money with short-term gains by acting as day traders, rather than long-term investors. However, because the stocks are so volatile, their price can change significantly literally as a trader is making the call to trade.
Where Penny Stocks Are Traded
Finding the right penny stock platforms often means looking away from stock exchanges. Most penny stocks priced under $1 will be found on the over-the-counter bulletin board (OTCBB) and through OTC Markets.
Major stock exchanges set a number of requirements for listing stocks, which usually include that shares must have a price of at least $1. However, you can also find shares that fall under the definition of penny stock priced between $1 and $5 on major stock exchanges such as the New York Stock Exchange.
Penny Stock Brokers
While researching how to find penny stocks, you'll quickly learn that you need to find a broker, first; without one, you won't be able to carry out your trades. There are several things to consider if you want to find the right broker for your needs.
Because your gains from penny stocks will usually be relatively small compared to other types of investments, you don't want your profits to be eaten up by the fees that the broker charges. If a broker charges on a per-share basis, buying lots of shares will be particularly expensive.
A flat fee makes more sense for penny stocks: Just make sure the broker you choose follows SEC regulations in the United States and allows for trading penny stocks.
Other important broker facts you need to be on top of include whether short-selling is allowed, how quickly you will be able to make trades (either online or on the phone), and what tools are provided with the broker's platform.
Watch Out for Scams
Penny stock scams are common: You can look out for some key signs that you're dealing with a fraudulent trade, not a genuine opportunity to make money.
Some of the warning signs of a penny stock scam include:
- Unregistered financial advisors guaranteeing returns
- Promises of quick and large returns
- Pitches the play on the latest trends and news stories
- Unofficial promotions
- High-pressure telemarketing calls from brokers
- Forums and newsletters with no clear affiliation offering advice and tips
Knowing some of the common scams can help you to avoid them. These include scams such as pump-and-dump and dump-and-dilute schemes.
Pump-and-Dump Schemes
These schemes are when promoters try to boost the price of a stock over time using misleading information or exaggerated statements. Investors who fall for it are often left with investments they can't sell. A variation of this is short-and-distort schemes, where promoters short sell stocks at high prices and then try to lower the prices with negative news.
Dump-and-Dilute Schemes
Dump-and-dilute schemes involve companies issuing shares just so that they can take money from investors. They will usually reverse-split the stock by consolidating shares to raise their value.
Chop Stocks
Chop stocks are bought for pennies and then sold on for dollars by illegitimate brokers and promoters to inexperienced traders. This often involves brokers being paid through unofficial channels.
Practicing Before You Buy
Before trading penny stocks for real, you might find it beneficial to practice. Various brokers and trading platforms offer free simulation tools for getting used to the ins and outs of trading. A demo account will give you virtual funds to play with and teach you how to navigate a live trading environment. It's a no-risk way to make sure you understand what you'll be doing.
Quick Tips to Get Started
To get started with penny stock investing, there are a few key steps that you can take.
- Do your research first - Don't start trading or investing in penny stocks before you understand what they are and the pros and cons they present. Some basic research can furnish you with the knowledge you need.
- Open a trading account - You need to open a trading account with a broker if you want to trade penny stocks. Consider the various factors involved in opening an account before deciding which broker is right for you. Fees are particularly important for penny stock trading, because high fees significantly impact your profits as they start to add up.
- Find the right stocks - You can use stock-screening tools to evaluate various stocks: You can use filters to search for stocks by price, industry, and other factors, based on your risk profile and strategy.
- Understand the risks - Penny stocks are inherently risky, particularly those not listed on the major stock exchanges. Prices can be manipulated more easily to make them appear weak or strong, so it's essential to be wary. Don't start investing in penny stocks until you're sure you understand their volatility and the risks you can face when buying and selling them.
By now, you should have a thorough understanding of how to buy penny stocks. They can be a good investment choice for people who have a high risk tolerance, but they should be approached with caution, especially by beginners.
Find the right broker for your penny stock trading by carefully assessing their reputation, checking their charges, and researching potential investments thoroughly.
Further Reading
FAQ
Can you get rich off of penny stocks?
Theoretically, you can get rich from trading or investing in penny stocks. You can make money from frequently buying and selling penny stocks or buying and holding stocks, and waiting for the price to rise over time. However, it's essential to remember that penny stocks can be very volatile and are inherently riskier than many other types of investments. You could get some lucrative returns, but you could equally quickly lose money.
How much money do you need to invest in penny stocks?
There are a couple of things to consider here: The first is whether your chosen penny stock brokerage has a minimum amount required to open an account. Some brokers may have a minimum amount as low as $500, while others might ask you to have thousands available to open an account. Penny stocks are cheap, so buying a few won't cost much. However, if you want to make a good return, you'll want to buy more than just one or two. Of course, this is riskier, as you’ll stand to lose more money if they don’t pan out.
Do penny stocks ever go up?
Yes: No one would bother trading or investing in them if they didn't. However, penny stocks are much more likely to increase in price by a tiny increment than they are to suddenly rise by a huge amount. If you buy a penny stock for $0.10, it could increase to $0.20, rather than suddenly being worth hundreds or thousands of dollars. It might seem like a small amount, but you could double your money, and the amounts could be significant for those who bought lots of shares.
How do beginners buy penny stocks?
The first thing a beginner needs to do to buy penny stocks is find a broker to open a trading account with. You will then need to start researching which stocks to buy. You can use several methods to find suitable candidates, including stock-screening tools. Before starting trading, make sure you're in a stable financial position.
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