Buying Penny Stocks: Pros and Cons
Investing in penny stocks has become one of the most popular choices for retail and institutional traders in the past few years. All over the internet, we see ads touting the next best cheap stocks or the potential of triple-digit percentage gains. And while this seems too good to be true, that’s because it is; for the most part. Every trader will tell you that there are no secrets that Wall Street has access to that you don’t.
With the right tools and information, everyone can be just as informed as the most educated investors are. It’s also worth noting that small and medium-sized gains can quickly add up. Over the past few weeks, companies like Auris Medical Holding Ltd. (NASDAQ: EARS) and Fortress Biotech Inc. (NASDAQ: FBIO) have made big gains. This has helped to increase the popularity of investing in penny stocks by quite a lot.
And while some investors benefit greatly from investing in penny stocks, others swear off of them because of the large losses that they may have accrued. With every story about a large winner, there are likely to be hundreds of stories of even larger losses. Now, I’m not saying that penny stocks aren’t worth it by any means. Rather, investors simply need to find all of the information that they can before sending in a buy order.
Before we go any further, let’s discuss a brief overview of what penny stocks are. The term penny stock means any stock that is trading under $5. This opens up the possibility to thousands of different companies. And while some are well under $1, the range of under $5 companies is not centered around any one price point. Penny stocks can be bought on the NYSE, NASDAQ, and OTC.
While the exchange is not always the most important part, it is something to consider for liquidity’s sake. Because penny stocks have gained a less than stellar reputation over the past decade, many investors avoid them. However, the chance of profitability can be much greater than with blue-chip stocks. For example, it’s more likely to see a $0.05 stock jump to $0.10 than it is to see a $100 stock jump to $200. Considering this, let’s take a deeper dive into the pros and cons of investing in penny stocks.
Buying Penny Stocks: The Ins and Outs of Utilizing Cheap Stocks to Make a Profit
- How to Buy Penny Stocks
- Avoiding Illegitimate Penny Stocks
- How Much Money do You Need to Make Profits With Penny Stocks?
1. How to Buy Penny Stocks
Buying penny stocks can be as simple as buying any security. But, it’s important to note that there are certain restrictions for trading penny stocks such as those listed on OTC markets. This depends greatly on what trading platform you use. For example, Robinhood will allow investors to purchase almost any stock listed on the NYSE or NASDAQ. However, it does not allow access to the OTC market.
A large portion of penny stocks are traded via Pink Sheets or OTC markets. This is due to the stringent requirement and expensive cost of listing on a large U.S. exchange that can not always be met by smaller companies. Because of this, they may choose to list on the OTC or over-the-counter exchange.
Also, many penny stocks do not meet the minimum bid price of $1 that large exchanges such as the NYSE and NASDAQ can require. So if you want to buy penny stocks, your best bet is to go through a broker such as E-Trade, TD Ameritrade, or Fidelity. One thing to keep in mind is that often, penny stocks can have low volume. This can lead to issues when trying to buy or sell. This is simply something that investors need to look out for. All in all, buying penny stocks can be easy with the right brokerages and tools at hand.
2. How to Avoid Illegitimate Penny Stocks
While many penny stocks are legitimate, there is always the potential to find less legitimate ones. This can be the case with blue chips as well, but it is more often seen with those listed under $5. The best way to avoid this is through research. As any investor will tell you, research will always be your best friend. But, what exactly are you looking for?
Well, one of the best resources out there is the OTC website (otcmarkets.com). This site will tell you point-blank if a company should be avoided or not. Additionally, most if not all information about a publicly listed company is available online.
This information will tell you what the company is doing, what its financial situation is, what its plans are for the future, and so on. While penny stocks on the OTC market are not always required to post information in the same way that big-name exchanges require, they will often disseminate information for the benefit of investors.
[Read More] Penny Stocks & 5 Rules To Know Before You Buy
Another aspect to consider and one that was mentioned above is liquidity. Because there are thousands of penny stocks both popular and not as popular, volume can sometimes be extremely low. This means that prices will change in a matter of seconds as orders are filled, with large gaps between pricing.
The Securities and Exchange Commission or SEC states that “Penny stocks may trade infrequently, which means that it may be difficult to sell penny stock shares once you own them. Because it may be difficult to find quotations for certain penny stocks, they may be impossible to accurately price.” Taking all of this into consideration, it is easier than imagined to avoid scams when looking for penny stocks to watch.
3. How Much Money Do You Need to Make Profits With Penny Stocks?
The short answer to this is that it all depends on what you have available. To simplify this, let’s talk about one example. If you invest $1,000 into a stock and make a 20% profit on a single trade, you will walk away with $200. If you invested $100,000 into that same stock, you’d walk away with $20,000.
As you see, it is all about scale. Now there are very few people who have the free income to put $20,000 into a single trade. But, if you can make consistent gains with the money you have to invest, those numbers can add up very quickly.
With penny stocks, there are two strategies. On one hand, investors can bet on the long-term future of a company. If you pick right, it could pay off substantially as prices go up in the coming months or years. On the other hand, traders can educate themselves on how to identify patterns in intraday movements. This is referred to as swing trading. While it’s easy to lose money when first starting; if you are committed to learning, there is a lot of value to be had down the line.
Are Penny Stocks Worth It?
Yes and no. For some investors, day trading or picking a long-term winner might not be the most viable strategy. If you’re not committed to learning and spending time going through charts/data, this may not be for you.
However, if you are, penny stocks can pay off in either the short or long term. Yes, penny stocks are right for some investors, but they’re not right for everyone. It’s important to distinguish what type of trader you are, to help define realistic goals for your portfolio. So after reading all of this, are penny stocks worth it or not? The choice is yours.