How to Trade Penny Stocks – A Beginner’s Guide

Updated September 21, 2022 GuidesStocks
Trade penny stocks

Learn what penny stocks are, how to trade them, and the pros and cons of this popular but volatile asset class.

While market titans like Microsoft and Amazon today command sky-high share prices, even they were trading for just a few dollars per share early in their history.

Their success proves that even relatively unknown companies with small market capitalisation can turn into runaway success stories, potentially providing life-changing returns to early investors.

The quest for the next Apple or Facebook is a popular refrain among investors and traders dealing in penny stocks, but this somewhat-romanticised view obscures the potential and pitfalls of this popular asset class.

What are penny stocks?

Penny stocks are stocks and shares issued by small-cap companies that trade for under USD5 per share.

While a small number of penny stocks may be found on major stock exchanges such as the New York Stock Exchange (NYSE), the majority of penny stocks are traded via over-the-counter networks.

Penny stocks tend to trade infrequently and have low liquidity. Combined with the comparatively less-rigorous reporting requirement for stocks traded via OTC channels, and the small size of the companies involved, penny stocks are considered to be highly speculative and carry greater volatility than mid-cap or large-cap stocks.

Why invest or trade in penny stocks?

Some investors are attracted to penny stocks for their low prices. It can be an appealing prospect to own several thousand shares with just a small budget, whereas the same amount might only buy you a few shares of a mid-cap or large-cap company.

Another reason why someone might invest in penny stocks is the higher volatility in share prices. When the price of a penny stock swings wildly up and down, the large price differences may potentially boost trading outcomes.

This potential for significant upsides can be attractive to investors focused on chasing short-term outcomes. Of course, downside exposure is also amplified to the same degree, and a losing trade involving penny stocks can have substantially worse aftermath.

A third reason to buy penny stocks is the potential for long-term and lucrative returns should the company prove to have a successful business model that enables it to grow into a stable and enduring enterprise.

How to find penny stocks

Because most penny stocks are not included in major stock exchanges, newcomers may wonder where they should go to look for penny stocks that appeal to them.

One good place to start is with OTCMarkets, a forum that collates over 17,000 OTC securities at the time of writing.[1]

Investors can search for and view information related to the largest collection of U.S.-listed penny stocks, which are categorised into three tiers based on the quality and quantity of the listed companies’ information and disclosure.[2]

Additionally, there are several websites and news portals dedicated to penny stocks. For example, pennystocks.com maintains a list of the top penny stocks being traded on the NASDAQ, NYSE, OTCQX, OTCQB & Pink Sheets, [3] making for a handy guide for newcomers looking to get into penny stock investing.

Meanwhile, penny stocks discussions, recommendations and analyses may also be found on websites and blogs focused on personal finance, investing and market news.

Examples of penny stocks

By definition, a penny stock is any stock that trades for under USD5 per share[4], which means you can find penny stocks across multiple different industries and sectors.

The following list of Top 10 penny stocks on the NASDQAQ and NYSE illustrates the diverse nature of the asset class. The companies listed below are only presented as examples of penny stocks and not a recommendation for investment.

Penny stockIndustry
Faraday Future Intelligent Electric Inc. (FFIE)Automotive
Sorrento Therapeutics, Inc. (SRNE)Biotechnology
iQIYI, Inc. (IQ)Media entertainment
Selecta Biosciences, Inc. (SELB)Biotechnology
Agenus Inc. (AGEN)Biotechnology
Clovis Oncology, Inc. (CLVS)Biotechnology
Nano Dimension Ltd. (NNDM)Hardware
BlackSky Technology Inc.(BKSY)Hardware
View, Inc. (VIEW)Construction
Cronos Group Inc. (CRONPharmaceuticals

Source[3]

Risks of trading penny stocks

Penny stocks may offer some unique propositions to investors, but trading in penny stocks is not without risk. In fact, the nature of penny stocks means some risks are heightened.

Look out for the following risks when trading penny stocks.

Lack of company information

Penny stocks are held to looser reporting standards than shares issued by larger, more established companies.

This means that there is less company information available (or if present, less easily verifiable, or of lesser credibility), which puts investors at a disadvantage, as red flags may go unnoticed.

Little to no company history

It is important to note that penny stocks are often companies that are newly formed or listed, or may be near the end of their business life. This lack of a track record makes it difficult to gauge the potential of a stock.

Low liquidity

Because penny stocks typically have low market capitalisation, investors and traders face the risk of low liquidity.

A lack of liquidity can prevent penny stock traders from executing their transactions – there may not be sufficient liquidity to support the sale of your holdings, and you may be forced to accept a lower price.

Penny stock scams

Penny stocks may carry a higher risk of scams, which can be perpetuated in several ways.

For one, the difficulty in verifying the foundation and background of a penny stock company can make investors unaware they are buying into a shell company that has no actual business operations and revenue.

For another, the low market capitalisation of a penny stock makes it susceptible to price manipulation, allowing scammers to carry out a pump-and-dump on unsuspecting investors.

Small-cap companies may also embark on campaigns to artificially inflate the price of their penny stock by paying influencers and media outlets to publish biased recommendations and content.

How to trade penny stocks

how to trade penny stocks

You can start trading penny stocks by signing up for an online brokerage that offers OTC trading. The popularity of penny stocks has prompted many brokerages to include OTC trades as part of their services.

Alternatively, you could also hire a stockbroker to help you make OTC trades, but this would likely come with a higher fee.

In addition, you can also gain indirect exposure to penny stocks by using financial derivatives, such as Contracts-for-Difference (CFDs), options and futures.

Using CFDs allow you to potentially create opportunities from price movements in either direction. If you think the price will go up, you can use a long trade to capitalise on the movement. Conversely, if you think the price will go down, a short trade can furnish a return.

Of course, you will only make a gain if the penny stock price moves in accordance with your trade. If the opposite happens, you will make a loss instead.

Penny stocks – high risk, high reward

It is important to note that penny stocks are a highly volatile asset class and carry a higher level of risk than larger-cap stocks.

There are also more dangers you have to watch for, such as an increased threat of scams, and a lack of credible or verifiable information.

Penny stocks may not be suitable for all investors. Anyone who is planning to invest or trade in penny stocks should only do so at an acceptable level of risk, practice sound risk management, and limit the use of leverage.


References

  1. Investopedia, OTC Markets Group Inc. https://www.investopedia.com/terms/o/otc-markets-group-inc.asp. Accessed 21 Sep 2022
  2. OTC Markets, Stock Screener. https://www.otcmarkets.com/research/stock-screener. Accessed 21 Sep 2022
  3. PennyStocks.com, List of Penny Stocks. https://pennystocks.com/list-of-penny-stocks/. Accessed 21 Sep 2022
  4. Corporate Finance Institute, Penny Stocks. https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/penny-stock/. Accessed 21 Sep 2022

Disclaimer
Vantage does not represent or warrant that the material provided here is accurate, current, or complete, and therefore should not be relied upon as such. The information provided here, whether from a third party or not, is not to be considered as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any financial instruments; or to participate in any specific trading strategy. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. We advise any readers of this content to seek their own advice. Past performance is not an indication of future results whereas reference to examples and/or charts is solely made for illustration and/or educational purposes. Without the approval of Vantage, reproduction or redistribution of this information is not permitted.

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