Penny Stocks Trading Guide: What Newbie Investors and Traders Need to Know

If you want to start trading at low entry costs with potentially significant gains, then investing in penny stocks might be an excellent choice for you. 

However, while penny stocks trading can be lucrative, with some making over 4,000% in gains in just a few months, they often come with great risks. 

Before investing, you’ll need to know critical details about penny stocks to ensure proper trading and minimize potentially massive losses. 

To help you out, we covered the essential things you need to know when investing and trading penny stocks. 

Penny stocks: A quick overview

Penny stocks are common shares of small public companies trading at low prices. 

The specific definition of penny stocks can vary depending on the country. For instance, in the United Kingdom, penny stocks are stocks priced below one pound, while they are priced five dollars or less in the United States.  

The U.S. Securities and Exchange Commission (SEC) defines penny stocks based on these features:

  • Highly illiquid
  • Issued by small companies traded below five dollars per share. This also includes shares of specific private businesses without active trading markets.
  • Stocks that are often challenging to price since price quotations for penny stocks shares are hard to obtain
  • Commonly traded over the counter (OTC), such as via the OTC Link LLC or OTC Bulletin Board. This also includes stocks traded on the securities exchanges (including foreign securities exchanges). 

Additionally, penny stocks are typically categorized as microcap stocks with a market capitalization of less than $250 to $300 million. 

Penny stocks vs. small cap stock

Small cap stocks and penny stocks can represent company shares with low market capitalization — companies with relatively small valuations. 

The difference between the two is that penny stocks trade at both a low price and market capitalization, often trading OTC instead of getting listed on stock exchanges. 

On the other hand, small cap stocks are not based on where they are listed or their stock prices, but solely on a company’s market capitalizations (between $250 million and $2 billion). 

An example of a penny stock is a share that a company trades at one dollar per share that isn’t listed on national exchanges but traded on the OTC bulletin board. 

A small cap stock can have more than five dollars and is traded on a typical stock exchange. A lot of small cap stocks are included in small cap indices and trade on stock exchanges. 

Benefits of investing in penny stocks

Some of the benefits of trading and investing in penny stocks include the following.

Easy entry

Getting started with penny stocks trading is fairly easy since you won’t need any degrees or special certifications. 

As long as you have a laptop or desktop with a reliable internet connection, you can create a brokerage account, and you’re pretty much good to go. 

No big account required

Unlike traditional stocks, where you would need to spend thousands of dollars to get shares, penny stocks prices are on the low end, making them accessible to traders with small accounts. 

This means you won’t need a lot of money to start investing in and trading penny stocks since you can buy shares for, let’s say, twenty cents and cash out at a dollar or more.  

Gains when penny stocks values go down or up

You can get potential profit as penny stocks’ value go up or down. Many companies who offer penny stocks tend to fail, but this provides opportunities for traders to sell short. 

With short selling, you’re betting the stock depreciates instead of buying the stock in the hopes it increases in value before you sell it. 

Or, you could buy penny stocks for cheap and get massive gains when their values start to soar. An example would be Amazon shares in 1997 that you could buy for five dollars or less, but now, Amazon trades at around $3,000.

Rewards for diligence

One downside to penny stocks trading is the lack of regulation since this can make it challenging to identify legitimate from fraudulent companies. 

However, this can also be a huge advantage if you know what you’re doing and do diligent research. 

With thorough research, you can learn about the companies that make good investments, increasing your chances of making significant profits and potentially striking gold.  

Potentially quicker profits

Penny stock trading is often fast and furious, with stocks moving 20%, 50%, or 100% quickly, allowing you to make gains within minutes, hours, or days.

As long as you implement the right strategies and understand the risks of trading penny stocks, you could gain significant profits relatively faster than when trading regular stocks. 

Penny stocks investing risks

While penny stocks can be excellent investment vehicles, they are inherently speculative because of their low liquidity and high volatility. 

This makes it critical for you to know the penny stocks’ characteristics that make them risky investments to help you understand what you’re getting into before diving in. 

Limited historical details

Most young and startup company stocks have limited historical information, making it hard to determine their potential. These companies usually lack proven track records about their products, revenues, assets, and operations, making it extremely risky to invest in them.

The key is to conduct thorough research to evaluate a small company’s legitimacy before investing in penny stocks.

Low liquidity

Most penny stocks are traded over the counter, making their liquidity low. This means you might not always sell the shares at the best time. 

Low liquidity also leads to low trading volumes, meaning relatively small transactions can cause large swings in the share’s prices. 

No requirements for minimum listing

Companies that issue penny stocks are not required to meet specific minimum listing standards since the stocks are traded over the counter. 

When a company can no longer maintain its listing position on a stock exchange, it can move over to a smaller OTC listing exchange without meeting standard minimum requirements.

This removes the safety cushion that minimum listing standards provide for investors, making it riskier to invest in penny stocks. 

Lack of publicly available information

It’s not mandatory for companies issuing penny stocks to file reports with regulatory bodies such as the SEC. The stocks are also not covered by professional stock analysts from specific financial institutions. 

This can make it challenging for you to find reliable resources to make informed investment decisions. 

Comprehensive research and working with an honest broker are critical, helping ensure you’re making the right investments with credible, legitimate companies. 

The final takeaway from our penny stocks trading guide

Penny stocks trading isn’t for the faint of heart. If you want to succeed, you’ll need experience and a thorough understanding of the field. 

While it is challenging, it’s not impossible. Start by knowing everything you need to know about trading and investing in penny stocks, and build your strategy from there. 

Once you get the hang of it, understand the risks, and spot legitimate companies. This should allow you (or with the help of a reliable broker) to gain significant profit from penny stocks trading. 

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