Penny Stocks – An Overview
What Are Penny Stocks
Penny stocks are defined as stocks that trade less than $5 a share. Generally though, penny stocks are stocks that trade less than $1 a share. In recent history, shares of now big name companies got their start as penny stocks, so there is money to be made in penny stocks.
Penny stocks tend to get a bad rap and for good reason. Nearly all penny stocks are not good investments. That’s not to say they can’t be good trades, they are just not something you would put in your 401k. Many of them are just shell companies put together for the sole purpose of a ‘pump and dump.’
A pump and dump is when a company or third party promotes a stock with claims of its the next big company to artificially inflate the price before ‘dumping’ their shares. There are many ways a pump and dump can work. Typically you see them with internet stock newsletters and even hard mailers.
A hard mailer is when a third party physically mails you a stock advertisement talking about how great the company is. Now as we said above, penny stocks are never good investments nearly 99% of the time. What you can do however is day-trade them for a quick profit. These type of trades are driven by one thing, hype. In extreme cases, stock promotions can send a stock from $1 to $10 – see stock symbol LEXG from last year. Always remember what goes up, always comes down and down fast in the land of penny stocks.
Why Trade Penny Stocks
So, if penny stocks aren’t good investments why should you trade them? People trade penny stocks because of the big percentage moves the stocks are capable of. Penny stocks can be dangerous to trade, but everyone loves the quick money you can potentially make off of them. If you buy a stock at $1 and it goes to $2, you make 100%. Now if you try buying a higher priced stock at say $10, it would have to go to $20 to give you the same percentage move. Remember, penny stocks can potentially make you money fast, but the flip-side is also true. Many have lost a lot of money very quickly in penny stocks.
Penny Stock Trading Tips
Let’s take a look at a few tips that can help you from being a losing trader.
1. Never Invest Money You Can’t Afford to Lose – Investing is kind of like gambling. Never use money you can’t afford to lose. If that means you can only start off with a few hundred bucks then so be it.
2. Don’t Invest Your Entire Account On One Trade – Putting your entire account on a single trade is NEVER a good idea. Pick a percentage of your account you are comfortable trading on a single trade, say 10%. That way if the trade goes south on you which will happen, you won’t lose all of your money.
3. You Will Lose Money – It happens to everyone. Some of the best traders lose 50% of the time, but they make sure to cut their losses as quick as possible. Never hope for a losing trade to turn around.
4. Trade Don’t Invest – Never invest in penny stocks unless you have done extensive research on the company you are looking at. Remember a lot of penny stocks don’t have up to date company info and financials.
5. Take Advantage of Stock Promotions – A lot of traders make most of their money on these type of penny stocks. Ride the hype up and sell along the way. Always try to not get caught in the dump day. Penny stocks are notoriously slow when it comes to executing orders.
6. Learn From Other Traders – There are many of successful traders who are willing to teach beginners. The best ones aren’t free however. Profit.ly is a great source for learning from the best traders and they post every single trade they make so you can see how well they do before picking one that best suits your trading style.
7. Paper Trade – Paper trade is a great way to learn how to trade. Paper trading allows you to use fake money to get used to trading. Many online brokers allow you to open paper trading accounts.
How To Trade Penny Stocks
So you’re interested in trading penny stocks, but not sure how to go about it. Well the first thing you need to do is open a trading account. There are many online brokers you can go with such as E*Trade, Scottrade, Ameritrade, etc. There are also specialty brokers you can choose from. Do your research and pick the one you like the best. Another great thing about some of these brokers is that they let you ‘paper trade.’ Paper trading is when you use fake money to trade stocks. This is a great tool for beginners as they can see how everything works and learn how to trade before using real money.
Once you have your broker, you’re ready to buy your first stock. Let’s go over the different types of orders there are. There are two main type of orders – limit and market.
Limit orders are the ones you want to primarily use. You specify a price you want to buy the stock at and the limit order will get you in at that specific price if possible.
A market order is extremely dangerous to use in penny stocks. Market orders trades the specific price for speed. A market order will execute your order as fast as possible at whatever price it can. This can cause your order to execute at different price than what the bid and ask are.
That’s why paper trading is so useful when beginners are first getting started. They can get a feel for how trading works before risking anything.
Risky Business
Penny stocks are risky business, but there are ways you can minimize your risks. One of the most important things to do is never risk a lot of money if you are a beginner. Never bet everything you have on a single trade or you will regret it eventually.
Don’t let your emotions rule your trading. This is easier said then done, but if you can limit you emotions impact on a trade you will become a better trader. If you get caught in a losing trade don’t hope for it to come back up. Take your losses and move on to the next trade.
Try out a premium newsletter. There are many traders who have made it big over the years that want nothing more than to teach other traders how to be successful. These newsletters aren’t cheap with some of them in the hundreds of dollars a month range, but the potential profits far outweigh the cost of them. A great site to check out is Profit.ly. This site has many traders on here all with verified trades. That way you can see just how successful they really are. Many different kinds of traders are on Profitly including short traders, swing traders and option traders.