Investing in penny stocks is like dating the high school rebel: It promises fast returns but ends with you developing trust issues. Most people don’t equate trading penny stocks with the safest way to see profits. Michael Sincere, author of “Understanding Stocks,” wrote in a MarketWatch article, “manipulators and scammers often run the stock game.” So why jump into a risky venture? Because there’s much to gain if you know the game.
- A Quick Glossary of Penny Stocks
- How To Invest In Penny Stocks as a Beginner
- Find a Broker You Trust
- How To Choose Penny Stocks
- Will the Real Penny Stocks Please Stand Up?
- Frequently Asked Questions
You might be asking, “What are penny stocks?” There are a lot of answers to this question, so let’s start off with some basic lingo. Familiarize yourself with this list of important terms before you invest in any low-cost stock opportunity:
- Penny stocks: Stocks for a small, struggling or start-up company that typically trade for less than $5 per share via over-the-counter transactions.
- Securities: Tradable assets with some type of monetary value.
- Broker-dealer: A business or broker that buys and sells securities for its own firm or on behalf of a client, respectively.
- Over-the-counter (OTC): Where a broker-dealer network trades company’s stocks that don’t meet the requirements for trading on a formal exchange.
- Pump and dump: An illegal scheme that involves boosting the price of a stock through false, and often emotionally driven, information; people with positions in the company’s stock create this information, then sell once the excitement drives the company’s share price higher.
- Shorting a stock: An investor borrows a security, then sells it on the market with plans to buy it back later for less money.
- Reverse merger: A cheap and quick way for a company to make an initial public offering. This usually occurs between a penny stock company and a developmental company to hype up the newly public stock price.
Every investment choice has its pros and cons. Keep reading to learn about the ups and downs of investing in penny stocks.
The Pros: According to a recent study by GOBankingRates, more than 47% of Americans are not investing their money, and 34% of those respondents said it’s because they don’t have enough money to invest.
This table details all the responses to the GOBankingRates survey question, “If you’re not investing your money in the stock market (not including retirement accounts like a 401(k) or an IRA), why not?”
|Why People Aren’t Investing In the Stock Market|
|Answer Choice||Percentage of Respondents|
|I don’t have enough money to invest||34.03%|
|I have no interest in investing||20.02%|
|I’m afraid I’ll lose money||18.52%|
|I am investing in the stock market||18.52%|
|I don’t know how to invest||14%|
|I don’t need to invest — I have an IRA or 401(k)||8.68%|
|I don’t have enough time to invest||7.87%|
By investing in penny stocks, you can start small by purchasing shares at low prices — say, 30 cents — and make 20% to 30% in a couple of days. This kind of low-impact trading might feel safer for beginners or those who can’t afford Apple and Google shares.
The Cons: Buckle up. Penny stocks are often associated with scams, which might include:
- Penny stock success stories: Don’t trust any penny stock success stories you read about in emails or see on social media or online. Typically, investors or companies who want to pump and dump their stock generate these kinds of tales.
- Manipulative tips: There are disclaimers at the bottom of those free penny stock newsletters that offer investing tips, but you might not read them, and that’s what companies want. The Securities and Exchange Commission requires the disclaimers to reveal that the “advisors” are paid by companies to pitch their stocks.
- False information about companies: David Goodboy from StreetAuthority wrote that pump and dump manipulators send out millions of false proclamations about companies to attract buyers. As Timothy Sykes, an expert penny stock trader, once said, “You can’t trust anyone.”
When choosing a broker, be aware of these red flags so you don’t end up with an untrustworthy one:
- Trade surcharges: Look for a broker who charges a flat commission instead of a surcharge. Some brokers will tack on a surcharge to stocks that are priced under a certain (low) amount and then charge more when they trade them. This might seem like an insignificant amount per share but remember that penny stocks are usually purchased in huge quantities, so that surcharge adds up quickly.
- Volume restrictions: Watch out for the brokers who charge for trading a large number of shares or limit the number of trades you can make in a day. These types of limits mean you’ll have to pay an additional commission for another order.
- Trading restrictions: Stick with an online brokerage site because it requires very little money to sign up. Any broker who will allow you to trade only via phone or imposes limits on the types of trades is likely manipulating the information you see.
Follow these instructions to find a broker you trust:
- Know the amount of money you’re willing to spend and lose and be clear with your broker. Start with a small amount, ideally 10% or less of your portfolio. Write that number down on a piece of paper and tape it above your desk as a financial promise to yourself. Stick to a specific monetary boundary even when things are going well because penny stock trades are high-risk ventures that can drop as quickly as they rise.
- Ask your broker questions about the different companies he or she plans to trade with, then research those companies. Check out their business plans and goals to determine if they’re feasible.
- Once your broker is trading, remember that you’re taking a risk, but have fun with it. And never, ever invest all of your savings into penny stocks.
Follow these guidelines to find the best penny stocks:
- Spend your time and money on penny stocks that trade at least 100,000 shares a day at 50 cents a share.
- Buy penny stocks that have shown an earnings breakout. It should look something like 52-week highs on a minimum volume of a quarter of a million shares per day. This might sound easy because there are so many penny stocks but remember that a lot of these are pump and dumps. Sykes said companies like Tangoes (TNGO) and Magal Security Systems (MAGS) are his benchmarks.
- Do not buy pumped-up penny stocks — you could be on the wrong side of a trade.
- Don’t fall for a stock’s exciting story. Limit your share size so you can get out of it faster. Your holdings should not be any larger than 1% to 2%.
- Diversify. Every investment decision you make won’t be a winner, so keep your portfolio diverse. If something goes south with one company, you want it to affect less than 3% of your portfolio.
- A 20% to 30% return is a big deal on a penny stock. But just because it happened in a short time doesn’t mean it’s heading toward a 500% return. Sell quickly and be grateful.
The Biggest Tip: Leave Feelings Out of the Picture
Enjoy the fantasy of getting rich quickly but stay grounded in reality. People buy penny stocks emotionally, and that’s how companies and brokers are able to pump up their stocks. Watch every penny stock as if it was a fast-moving game — not your ticket to paradise.
Don’t ever buy a penny stock that someone describes as “hot.” It’s not. It’s more likely a scam. According to Timothy Sykes’ blog, these are the best penny stocks to watch right now:
- Discovery Gold Corp (DCGD): The marijuana business, which has proven lucrative for many investors, is DCGD’s focus.
- Northern Dynasty Minerals Ltd. (NAK): A mineral exploration company with a sizable gold and copper project in Alaska.
- Research Frontiers Incorporated (REFR): A nanotech company coming out with “Smart Glass,” a product that enables you to change a window tint with a single touch.
- Veritas Farms, Inc. (VFRM): A 140-acre cannabis farm in Colorado that just struck a deal to sell its products in more than 1,000 Kroger stores.
- Valuesetters, Inc. (VSTR): A company that raises capital, enhances economic developments, develops cutting-edge technology and does digital marketing. It’s been crushed by its competitors, but this is where penny stocks thrive.
For Less Risk: 12 Stable Investments Everyone Needs in Their Portfolio
When it comes to investing, there’s no such thing as a dumb question. It’s your money, after all. Here are the answers to some of the most common questions about penny stocks:
Q: When is a good time to actually start trading?
A: The best time to start penny stock investing is when you have funds that you can afford to lose. Make sure you remember that these trades can be potentially volatile, so you don’t want to feel crushed if you lose your money.
Q: What is the easiest way to spot a pump-and-dump scam?
A: The five strongest indicators are:
- If someone reaches out to tell you about a “hot” penny stock in an email or on social media.
- If a penny stock is shooting high around the same time that someone is telling you to invest in it.
- If someone is making guarantees about returns on the stocks.
- If an unregistered brokerage firm is selling penny stocks.
- If an inactive penny stock has a sudden increase in volume.
Q: Can’t I become rich just by copying the trades of experts like Timothy Sykes?
A: In short, no. Everyone has different instincts and financial goals. If you want to play the short game and make quick returns, it’s best to not follow someone who makes their money by trading penny stocks long term. Play around in penny stocks with a small amount of money at first — you might be a penny stock savant, but you’ll never know until you do it your way.
Q: What’s the minimum amount of money I need to start investing?
A: Top penny stock brokerage firms like Charles Schwab and TD Ameritrade require a minimum deposit of $0, while others, such as E-Trade and Trade Station, require a $500 minimum. However, experts recommend you start with a minimum of $2,000 so you can short sell penny stocks, which is a pretty basic trade.
Keep reading to find out which beaten-down stocks investors love again.
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Jared Nigro is a writer in Los Angeles. He works with financial and environmental organizations, such as the Dan & Susan Gottlieb Foundation and Inside Out Writers.
Last updated: Sept. 25, 2019
This article is produced for informational purposes only and is not a recommendation to buy or sell any securities. Investing comes with risk to loss of principal. Please always conduct your own research and consider your investment decisions carefully.