How to Buy Penny Stocks in 2021
The misconceptions around investing in stocks that trade per share prevent many people from making valuable investments. Trading can be intimidating to folks who feel like their knowledge and income level is too low to make smart investments in the stock market.
It doesn’t have to be like that. The truth is there are opportunities to build wealth with stock market investments at any income level. Gaining knowledge in investment opportunities can help you turn a few pennies into a healthy nest egg.
The term pennies is literal when talking about investing in the best penny stocks. If you know where to look, there are stocks per share available for cents per share that have enormous growth potential. Technology is increasing the availability of knowledge and access to investing in penny stocks. While this doesn’t come in encyclopedias with a table of contents the information is getting easier to find.
Plenty of resources are available to access financial advice and electronic trading platforms for stocks of small companies at affordable rates. It can all be waiting for you on your personal mobile device or laptop.
Read on to gain resources and valuable information on how to buy penny stocks that will significantly grow your investments.
What is a Penny Stock?
For any large investment portfolio to withstand the test of time, it has to start on a solid foundation of information before purchasing your stocks. To start, what is a penny stock?
Penny stocks are stocks, usually, of a small company. To be considered a true penny stock, the per share price should be less than five dollars (USD) each. In the past, to qualify as a penny stock the per share price had to be under one dollar each. In recent times, however, the US Securities and Exchange Commission (SEC) adjusted the definition to include any shares under $5 per share. Many of these small companies penny stocks trade for literal pennies (with a stock price under $1 USD) or for just a few dollars each.
The low price point of these small company shares can make them attractive to potential investors with smaller budgets. Even with low liquidity you can get in on the action. Because of the low initial price point, there is more opportunity for growth.
That opportunity for growth, however, comes with a bigger risk. These smaller, less established companies may or may not experience significant growth as a company. A large percentage are just starting out and have very uncertain futures. Larger companies are able to absorb more risk and failure, while smaller companies could fold after a mistake or economic downturn.
As with many investment opportunities, the larger the potential growth, the bigger the risk. A stocks penny trade can be highly speculative. Therefore, it is advised to seek out information on the companies before buying penny stocks. Always do research, ask for advice, and then do research again.
How to Buy Penny Stocks
The majority of stocks trading, that the average individual is familiar with, trade on major stock exchanges like the New York Stock Exchange (NYSE) or the National Association of Securities Dealers Automated Quotations (NASDAQ). Other major international stock exchanges include the Tokyo Stock Exchange, Euronext, and others. Images that come to the mind of many people when they think about stocks trading include trading floors, flashing displays, and organized chaos. This type of environment only exists in those larger stock exchanges, not the penny stock. Penny stocks trade in a much less luxurious setting.
While a tiny fraction of penny stock can be found on those larger exchanges, because they are risky investments, how to buy or sell penny stocks is using over-the-counter (OTC) transactions. All OTC transactions occur electronically, not on a physical trading floor. So, you make money virtually since most aren’t listed on a major exchange.
OTC transactions operate through electronic transactions either on OTC Bulletin Board (OTCBB) or the OTC Markets Group. Penny stocks can also be found on a listing called the Pink Sheets.
About OTC Bulletin Board and OTC Markets Group
The OTCBB as it is more commonly known, is provided by the Financial Industry Regulatory Board (FINRA). It is an electronic quotation service for FINRA subscribers to manage their investments. The OTCBB was developed in 1990 after the SEC was required by recently passed legislation to develop a centralized location for investors to manage stocks that were not available on the major stock exchanges.
The major stock exchanges have certain requirements of businesses in order to trade on their exchange. Smaller businesses often didn’t meet the requirements for the major stock exchanges. Before there was the OTCBB, these small businesses did not have a centralized location to trade their shares.
With these alternatives, smaller businesses now have a way to earn capital to grow business by trading shares at lower price points. This is attractive to investors who are willing to take bigger risks on lesser known companies for an often much larger return on investment (ROI).
These alternatives are not just smaller versions of the major exchanges. Specifically, they are quotation services that all operate on a centralized server that can be accessed by subscribers. The trading, buying, and selling of penny stocks can be a bit different because of these technicalities.
About Penny Stock Pink Sheets
Most people think about the movie, the Wolf of Wall Street, with Leo Dicaprio when they think about penny stock. The movie showcases the pump and dump schemes of the 1980s when a small firm started beating major exchanges. They come in like amateurs and end up taking over the industry. They become brokers and traders by finding investors willing to buy stock in companies that aren’t the best, pump and dump the stock for epic profits, and start the game all over again the next day.
Historically, pink sheet stocks received their name from the color of paper these stock listings were printed on. Over time this has come to refer to a listing of small-company stocks that trade outside of the major stock exchanges and the OTC electronic quotation services. In many ways, stocks on these sheets are the rebels of the investment world.
These sheets are filled with smaller companies that do not qualify to be listed on the major stock exchanges (NASDAQ, NYSE, etc.). They also exist outside of the OTCBB and the OTC Markets Group. It is a private listing for OTC sales.
Stocks like this can be a tricky, risky investments for several reasons. These stocks carry all of the same risks that OTC sales of penny stocks hold while also maintaining short term private financial information.
Companies that trade on the electronic quotation services are under regulation by the Securities and Exchange Commission (SEC). The publicly traded companies are required to adhere to the SEC’s trading rules and regulations.
Pink sheets are not under oversight from the SEC. This means they do not need to release as much information publicly. Pink sheet listings are required to submit some information to OTC Compliance Unit, but it is less than the requirements for listing on the OTCBB or OTC Markets Group.
All of the factors (less public information, smaller companies, etc.) involved with pink sheets make sure these penny stock investments are very high risk. It would take in-depth and intense knowledge to understand which pink sheets could prove fruitful so they trade infrequently.
Another risk involved with pink sheet stocks is the higher potential for fraud. Because the companies are under fewer reporting regulations, there has been a history of companies listing themselves on this market as the company is on the verge of collapse. This is in an effort to pump and dump the value of the stock to boost their low liquidity.
Traders dealing in penny stocks have sometimes been a last grab for money as the doors were closing. In some instances, companies’ stocks listed in these markets were discovered to not even be real and were completely fraudulent transactions. They used shady brokers and traders listed to buy and sell their stocks without a company at all.
If you choose to accept the risk of pink sheets trades, be mindful and do plenty of research on the penny stock you’re considering. Find brokers who will help you find the best match with your budget and the best traders that know how to find the winners. With all the other opportunities available, it isn’t advised for newcomers to start with the pink sheets. It is especially not advised for pink sheets to be the sole stock investments in a portfolio. This isn’t the pump and dump 80s after all.
Where to Trade Penny Stocks
Smaller businesses with share rates that qualify for trading penny stocks need to find ways to trade outside of the major stock exchanges like NYSE or NASDAQ. There are brokers who specialize in penny stocks but you have to dig to find them. To start trading penny stocks, look into electronic quotation services that provide a centralized digital platform to buy, sell, and trade penny stocks. With the low price point, it is helpful to find companies that minimize the amount of commissions, trade fees, and minimum balances. A $5 commission can eat into a penny stock investment much quicker than a company that trades at $1,000 a share, for example.
The following are fantastic online brokers and traditional places to trade penny stocks with zero commission and all rights reserved:
- Charles Schwab
Apps that Trade Penny Stocks
Stock traders mobile apps like Stash and Robinhood are gaining fast popularity among newbie stock investors. Success stories surging around the internet of investors hitting it big have boosted their popularity. The apps provide an easy way for investors to get started in stock investments with low account minimums. For example, the mobile trading app Stash allows users to open an account with a minimum of just $1 investment and a $1 fee each month.
The majority of mobile apps are letting investors trade on the major stock exchanges and no not offer penny stock options. The low priced entry point is buying percentages of larger shares on major stock exchanges like NYSE and NASDAQ (and some major international stock exchanges as well.)
The world of mobile investors is starting to get into penny stock trading, however. The following investment companies offer penny stocks and an online brokers trading option:
- Charles Schwab
- Fidelity Investments
Mobile apps are a convenient way for investors to manage your penny stock investments. Generally, a robo-investors is part of the experience. This a cheap and user-friendly way to buy, sell, trade, and manage penny stock investments. Because penny stocks value can quickly change, having the option to monitor your investments on your mobile devices could help you avoid a big loss or score a big win.
Costs of Penny Stock Trading Platforms
In addition to the cost of the investment itself, investors choosing to use a trading platform comes with certain costs. As outlined above, there are plenty of trading platforms that charge zero commissions to trade. Trading commissions used to be a big expense of stock investing, but technology has lowered the overhead. Now most firms charge zero or very commissions. While others charge zero commissions, but do charge trade fees per trade.
In addition to trade fees and commissions, there are other costs to consider when choosing a trading platform. Many platforms require a minimum investment. With some platforms, there are fees if the balance drops below the minimum investment. Before diving in, determine what your budget is for the minimum investment. This can help you eliminate any platforms where the minimum investment is outside of your budget.
With the investment apps and platforms, some require a repeating membership fee. Usually, these costs are relatively low, but it is something to be aware of.
Tips for Trading Penny Stocks Successfully
Stock prices can be confusing if you don’t understand how the true value of shares is calculated. Individual stock prices are only half of the true value of the stocks. To determine the true value, you have to understand the real business value of the stock or the market capitalization. Market capitalization is determined by two things:
- The price of the individual stock
- The number of shares outstanding
Shares outstanding are how many individual shares of stock a company has made available. A penny stock that is trading for $1, for example, and has 100 million shares has the same market capitalization as a firm that trades $100 shares with 1 million shares outstanding.
Understanding this can help avoid overvaluing a penny stock and its potential return on investment (ROI).
Once you have a better grip on the market capitalization of penny stocks, you can make informed decisions. To make the most of trading penny stocks, there are some rules of thumb to follow:
1. Avoid paying commissions. With the smaller value of the penny stocks, those commission fees could make significant dents in your ROI. Sometimes smaller profit margins mean you need to operate lean. There are plenty of commission-free trading options available, so always check the policies and fine print of any service or brokerage before investing in penny stocks.
2. Diversify. With great risk comes great reward, but it also comes with loss. In an overall investment portfolio, penny stocks should only be one element. Diversifying investments will prove the most fruitful and balanced in the long term.
3. Research. And then Research Again. With penny stocks, research is critical to making smart money moves. Dig into all information you can find directly from the company, but don’t stop there. Third-party information will provide a clearer picture of this company’s value and ensure that you aren’t only receiving a rose-colored picture from the company itself.
Expand your research even further and find out what is happening in that company’s industry. Is the industry experiencing growth? Is that industry oversaturated? Is the company doing something that will set them apart from competitors? Make sure you have a solid understanding of the company’s position before plunging into the penny stocks.
4. Follow Investments Closely. Even more so than with the major stock exchanges, you will want to follow your penny stock investments. If you have invested in major or blue-chip stocks in the past, you have probably received advice to hold onto the shares for the long term as the market generally tends to grow over time. Penny stocks are a different beast.
The prices of penny stocks can swing quickly and wildly. The positive is that this can be exciting. Penny stocks have the potential to make significant money in a short amount of time. Alternatively, the stock could quickly dip or the company could even fold. Watching the turns in the value will help you know when it’s time to sell and get out to protect your investment.
Common Mistakes and Pitfalls of Penny Stocks
Making smart investments means staying informed and understanding the real risk of penny stock investments. The following are common mistakes of buying penny stocks.
1. Assuming large growth. A common misconception about penny stocks, especially for beginners in the arena, is that all penny stocks will provide a larger profit margin because of the low buy-in point. Technically, the potential for growth is larger with a smaller buying point. That is mathematically correct, but it does not guarantee that all penny stocks will experience significant growth.
There is always the potential for huge growth, but it is not an eventuality. Sometimes penny stocks are valued so low because the company and shares are just not worth as much. There is always a risk in losing the entire investment with stocks and with penny stocks that risk is greater. The lower price point puts penny stocks closer to zero from the start.
2. Failing to do research. Continuing from point number one, not all businesses trading penny stocks are created equal. It is imperative, maybe even more so than with major stocks, to do diligent research on a company before investing. Great questions to ask are:
- Is the industry this company is in growing?
- Is this company doing something innovative or different than competitors? Will this provide this company an advantage?
- Who is the leadership? Have the leadership of this company had successful ventures in the past?
3. Not seeking professional advice. Like so many things in life and business, asking for help from a seasoned professional is the smartest move. If you have access to a live person that has experience trading penny stocks, that can be your best resource. If that is unavailable, there is plenty of expertise in online articles, blogs, and forums to help guide your decisions.
4. Investing more than you can truly afford. Penny stocks can deliver exceptional return. On the flip side, however, penny stocks can have a bigger potential to fail. Be confident that whatever investment is made in penny stocks will not financially ruin you if the investment doesn’t work out.
In conclusion, penny stocks can be an exciting and beneficial investment opportunity for the right investors. Penny stocks offer a low starting point, active participation, and huge potential to make serious cash. Not to mention, the process of learning the penny stocks industry provides ample opportunity to improve overall financial and investment knowledge. Once you successfully navigate making money in penny stocks, you can have an overall better understanding of all stock investments and how they can benefit your personal portfolio.