A Beginner’s Guide to Trading Penny Stocks
How to invest in penny stocks for beginners
What are penny stocks? Penny stocks are shares that are traded at very low prices. There are several factors that make them attractive to many investors, but they are not always the best options. Many are the times when people have made quite a killing from trading small sums in penny stocks, and many are those who have also suffered epic losses.
Like any investment, you must weigh the risks against the potential rewards. There’s nothing wrong with walking away completely, especially if you feel it’s too risky. In fact, this is the best thing you can do because usually, penny stock investments end up in losses.
However, based on many research studies, most people fail when investing in penny stocks because they invest in the wrong stocks, for the wrong reasons, and at the wrong price. These are risks that you can avoid taking the time to research and learn the intricate details about investing in penny stocks, as you will in this article.
One of the biggest mistakes people make is to invest in counters on the dark markets. This is the easiest way to lose money. Instead, you need to focus on investing your money with serious companies that trade on regulated exchanges. Invest in legitimate businesses and your money will grow.
Serious companies are companies that have sharp business models. They trade for pennies in the market because they are relatively new, and having just been listed, they are still too small. Based on their business model, these companies eventually start racking up value and trade for dollars.
Risk Money and Honest Guides
How to buy penny stocks for beginners
The first rule of trading in penny stocks is never to invest funds that you cannot afford to lose. In fact, you should have some money set aside for this purpose. Learn about the market before you get ready to invest in these shares. You need to understand how volatile the market is. Stocks that trade at the lowest prices are highly volatile, so you must be ready for this.
Given the wide access to social media, get in touch with and follow personalities who understand the industry better. Ask for help when possible. Expert traders can help you avoid disastrous moves in the market. In fact, you will learn a lot based on their experiences. As a matter of fact, in any project you undertake in life, be it yoga, cooking, home renovation or investing in stocks, your results will always be as good as your guide. There are several mentors in the market that you can learn from. You just need to be careful about whose wise words you heed.
You will come across people who talk a lot about sports cars, private jets and luxurious mansions, which they may or may not have. These are the earliest warning signs you should look out for. Such people try to sell you the idea of a lottery, which is all down to luck, and not on how the market operates.
Heavy Metal Lottery Tickets
For most people, greed and the allure of quick riches make them let down their guard, tempted by the prospect of turning a few dollars into financial freedom overnight. This is actually how scams are run.
There are several scams that have wiped out people’s investments in the past, and they all promise the same incredible returns by investing a very small sum. This is not a new phenomenon in the financial markets, but something that has been going on for a very long time. Even at the moment, a lot of people are losing a lot of money by investing in get rich quick scams.
Don’t lose your hard-earned cash through these lottery-type promises. You should take time and research well before you’re ready to invest in penny stocks.
Start with Paper Trading
Through paper trading, you can learn how to invest in the penny stock market without using real money. In this method, you will take note of imaginary trades in real stocks, build a portfolio and try to manage it. When learning about penny stocks, this is one of your best options.
You will learn how to track profits, how to respond to volatility in the market etc. With this knowledge, it becomes easier for you to invest in the market with real money. Through paper trading, you also get accustomed to some of the terms that are used when penny stocks trading.
For someone who’s just starting out, you will make a few mistakes here and there. However, make sure to learn from them before you venture into the real market. You will also learn some of the signs to look for when in search for a sure winner to put your money on.
Try your hands at paper trading for a few months until you have mastered what it takes to thrive with speculative investing.
Choose Carefully the Types of Companies You Will Focus On
How to find penny stocks
A lot of investors lose money because they invest in what they consider the hottest thing in the market at the moment. These are companies that are hot on everyone’s lips. You will see them in the news almost all the time, even your Uber driver will mention one or two things about them.
The problem with this is that by the time everyone is talking about a certain stock, it’s already crowded. Everyone has been buying in, and the stock is probably too overpriced. At such a time, chances are high that the stock will drop in value.
This is one of the biggest risks in penny stock trades. When a stock is no longer the in the thing, everything in that industry collapses, and so does your chance at making a killing. The wisest thing you can do in penny stock trades is to invest in something you understand very well.
Let’s say you are in the health sector, for example. You probably understand the developments in the industry, and you’re in the best position to invest in biotech stocks. IT gurus and programmers have better insight into tech companies, and so forth.
Your Personal Interests
Like most investors, you might not be sure of the best industry to invest in. Instead of throwing caution to the wind, consider investing in things that you’re passionate about. Often, people venture out into uncharted territory and don’t see the opportunities in the industries they are closer to.
If you are passionate about fashion, that’s where you can make a lot of money. You already have an advantage over most investors because of your in-depth knowledge of this industry. The mistake that most people make is that they delve into markets that they don’t know about, hoping this will make a big difference.
Unfortunately, the society has this predisposition to run away from the boredom of the norm. When you are done with work for the day, you want a change. If you are a chef, for example, you hardly want to slave in the kitchen when you get home. Security officers just want to get home and be loving parents.
To invest in penny stocks, you have to rethink your strategy and work around this psychology. You’re technically giving up your upper hand in the industry. These are the companies that you understand too well. To invest in penny stocks, you must properly use your information bias in such industries.
Generating Prospective Investments
Next, you need to look for several reliable sources from where you will get potential investments to wager your money on. As a rule of thumb, no source is always 100% perfect, and you should have several options to look at. Use your sources to identify companies you can follow and research on, but don’t trust this information fully. Trust your gut. Analyze the information you have and make up your mind based on what you believe is the best course of action.
With the help of stock screeners, you can easily find stocks to invest in. These are good tools that can help you understand how and when to invest. You can also use these tools when paper trading, so you can learn more about making wise investments.
Most of the financial trading portals have stock screeners that you can use. In fact, Google has a free stock screener. You can define the search category accordingly. Say you are looking for stocks that trade at $2 or less in a specific industry, the screener will filter and give you just that. Based on the results returned, you can shortlist and identify the stocks you’re comfortable trading in.
Common Penny Stock Fallacies
When it comes to trading penny stocks for beginners (most especially), there are two common fallacies you will probably come across:
- Most of the stocks in the market today were once penny stocks
- There exists a correlation between your returns and the number of stocks you own
Most of the investors who have fallen for these tricks believe that stocks like Microsoft (MSFT) started out as penny stocks before appreciating in value to what they are today. The problem here is that you will focus on the adjusted stock price, only looking at the stock splits. Microsoft, for example, started trading at $21. Adjusting for stock splits, the trade comes to around 8 cents. Therefore, they actually listed in the market at high values and kept rising until a share split was necessary.
Another reason why people are drawn to penny stocks is that of the assumption that there’s always room for value appreciation and the opportunity to own more stocks. Look at it this way, a stock that trades at 10 cents will earn you a 50% return if it makes a marginal rise by 5 cents. Other than that, if you were to invest around $1,000, you are basically buying thousands of shares of such stocks. Therefore, most investors are convinced that they can increase their profits by trading this way.
Sadly, most people are blinded by the good side of penny stocks and overlook the dark side. Your 10-cent stock might as well lose 50% of its value. There is also a chance that the stock might not succeed in the market, and your investment will be wiped out.
Reasons Why Investors Fail with Penny Stocks
Are penny stocks riskier than other securities? The answer depends on the type of exchange where the stock is listed. Established exchanges like the NYSE and NASDAQ have stringent measures that have to be met before listing companies.
They must check the company’s financials, the board of directors, shareholding capacity and so much more, to ensure that potential investors are protected. Any company that fails to meet the screening requirements might still trade over the counter (OTC) in marketplaces like OTC Pink, OTCQX and OTCQB. Unlike the other two, OTC Pink is the preferred marketplace for most penny stocks because of the flexible reporting requirements. OTCQX and OTCQB must report to authorities within the financial sector or the SEC.
Companies that are listed on OTC Pink will in most cases not have assets or revenues, or if they do, they might be going through a financial depression. They might leverage on debt, have terrible balance sheets, or might simply be trying to raise money from the public to get out of trouble.
You will also lose money when investing in penny stocks because you don’t have relevant historical or current information about these companies. For more information, you can visit the SEC website, research online, visit finance websites, read print media and check any other source of information that you can trust.
With penny stocks, on the other hand, it might be difficult to find information about the companies, their services or operations. Usually, some of the anchor products are yet to be tested in the market, so there’s a high risk of failure. This lack of information further increases your risk when investing in such stocks.
Penny stocks are also ripe for price manipulation. As a result, the list price is barely ever the real value. You will not find credible analysis anywhere by experts or brokerage firms. Most of the penny stocks trades are done by brokers who are more interested in sealing deals than giving you a good return on your investment.
They make underhand deals to connect the seller and the prospective investor, so in most cases, penny stocks never reflect the opportunities, stakes, prospects, risks or the true worth of the company.
This lack of clarity and information is one of the reasons why penny stock investors are often vulnerable to fraud. Besides, they are primarily traded in small volumes. Because of this reason, there are market players who can influence the stock price by acquiring enough counter volumes. After doing that, they might engage in serious marketing to generate hype around the stock. After they have generated sufficient interest in the stock and have locked in their threshold purchases, they sell their shares at the artificial price they create, while the buyers are left holding useless stocks.