Penny stocks are a unique category of equities. These stocks are volatile propositions, unsuited to traders with a low appetite for risk. The Securities and Exchange Commission (SEC) defines penny stocks as equities that trade under $5 per share. The stocks are typically traded OTC (over-the-counter), or as Pink Sheets. Owing to the nature of penny stocks, it is wise to be cautious when selecting penny stocks to trade. In this guide, you will be introduced to 7 tips for trading penny stocks online.
- Start Reading About Penny Stocks
Every trader worth their salt understands that the markets are complex interrelated systems. Penny stocks companies by their very nature are typically small with low market capitalizations. They may be in their infancy stages, or further along in the business cycle. Either way, they have low media exposure and typically struggle to get the attention of key market players.
In-depth research is needed to identify high-value penny stock propositions in the markets. With low liquidity (they are less frequently traded), it may not always be possible to find buyers for your stocks. As a rule, never purchase more penny stocks than you are willing to lose. This is very well explained in this penny stocks guide by Timothy Sykes.
Consult company profiles, earnings reports, newspaper reports, stock reports, company prospectus data, and anything related to the penny stock you’re interested in trading. Many world-famous companies actually started out as penny stocks – Facebook (FB), Amazon (AMZN), Apple (AAPL), Monster Beverage Corporation (MNST), and Ford Motor Company (F) are cases in point.
- Pick a Reliable Broker for Penny Stocks Trading
Given all the shenanigans that take place with many penny stocks companies, it’s always best to pick a reputable brokerage. These brokers should offer you penny stocks trades at low cost, or no cost. Be advised that certain brokers which promote themselves as the low-cost leaders may not necessarily offer you the best options vis-a-vis penny stocks trading.
For example, you may be limited to a small number of trades per day, which is disingenuous for day traders. The brokerage’s T&Cs outline any restrictions which may exist, including details of the fee structure. Look out for Depository Trust & Clearing Corporation eligibility with penny stocks trading. The absence of DTCC eligibility may warrant additional fees.
- What Type of Penny Stock Are You Looking to Trade?
Penny stocks exist for many different types of companies, including biotech, pharmaceutical, green energy, et al. However, the specific type of penny stock should also focus on the tier of the stock. Tier 1 penny stocks are ideal, since they are listed on the New York Stock Exchange, or the NASDAQ composite index. These have to comply with the rules of the exchanges, so their best to trade.
Tier 2 penny stocks trade between $0.01 – $0.99 per share. Tier 3 penny stocks are probably best avoided, since these trade at less than 1 penny per share, and they are not listed on the major exchanges at all. Tier 4 penny stocks are known as trip zero stocks, and they are priced at 100th of a cent.
- Use Stock Screeners to Identify the Best Penny Stocks
It’s challenging to identify strong performing penny stocks at the best of times. With so many of these stocks listed OTC, and as Pink Sheets, finding top performing penny stocks is exceptionally challenging. Stock screeners are powerful tools which automatically scan the markets for penny stocks which have the potential for strong gains.
Momentum indicators, such as Moving Averages, Bollinger Bands, Ichimoku Cloud, and Relative Strength Index are particularly useful in this regard. Be sure that you understand why the stock scanners have identified specific penny stocks as viable propositions. A little technical analysis will certainly bring everything into sharp focus.
- Always Begin with Paper Trading
Paper trading is particularly useful for stocks traders. This form of trading activity mimics real-world trading conditions without any real money changing hands. Paper trading, while certainly less intense – since no real money changes hands – can be a powerful tool to use when implementing different strategies with your trading regimen.
Be sure to document all your winning trades, losing trades, and lessons learned from paper trading activity. This form of trading is virtually indistinguishable from real money trading. A word of caution is advised: real money trading is worlds apart from paper trading, because there is absolutely no risk of loss with paper trading. This means the emotional highs and lows, the angst and the excitement are absent in paper trading.
- Change the Traditional Mindset of Stocks Trading
As a standard investor in the stock market, your mindset is one where you buy a stock, and wait for the stock to appreciate. That linear approach is an old school approach to making money. You buy low and sell high. With penny stocks, that simply doesn’t work. The majority of penny stocks you trade will ultimately fail.
These companies are unproven, many of which are simply ideas with a prospectus of what they would like to achieve. Therefore, there is no emotional component when trading penny stocks online. Here’s the thing: penny stocks experience extremely volatile runs. They could spike several hundred percent, and then plummet spectacularly to 0. It’s up to you to catch them on the way up, and sell them for a hefty return.
- Look for Patterns, Trends, and Cyclical Behavior in The Charts
Experienced traders know that ‘The Trend is your Friend’. This means if a stock is trending bullish, it is likely to continue moving in that direction. If a stock is trending bearish, it’s likely to continue trending in that direction. Going long (positive expectations), and going short (negative expectations) are standard actions in stock trading.
Study the charts, and try to unravel the patterns that are emerging. Technical indicators are a powerful tool to use in this regard. The momentum indicators are reflective of current market sentiment – bullish or bearish, and they should always be used when determining whether to short the stock or to go long on a stock.