Trading in penny stocks can be a profitable endeavour, if the investor does adequate amount of research and doesn’t get swayed by the myriad of newsletters and email scams promoting trashy companies. The investors will benefit by following a few important steps, while trading penny stocks.
The Basics-What are penny stocks
There is no accepted definition of a penny stock, also known as over-the-counter (OTC) stock. Usually, a stock, which doesn’t trade on the major exchanges like the New York Stock Exchange and the NASDAQ, quotes at a price of less than $5, is highly illiquid and speculative is accepted as a penny stock, according to the Investopedia.
As there is no standard norm, a few brokers consider stocks quoting under $3 or …show more content…
$1, as penny stocks.
Where do the penny stocks quote?
These stocks are quoted on the smaller exchanges like the OTC Bulletin Board or the OTC Markets Group (erstwhile Pink Sheets). Around 10,000 securities can be traded in these exchanges via online brokers.
Which are the online brokers that allow trading in penny stocks?
There are a number of brokers that offer trading in penny stocks. However, it is better to open an account with a regulated penny stock broker, because the unregulated brokers charge exorbitant commissions, have a number of hidden charges, and are involved with scamsters in promoting worthless stocks leading to large losses to the investors.
Some of the reputed brokerages that offer penny stock trading are Choice Trade, Charles Schwab, Interactive Brokers (IB), Scottrade, TDAmeritrade (AMTD), and TradeKing, etc. There are a number of other regulated brokers, but the investors should stick to the recognized ones.
Important points to remember while opening an online trading account for penny stocks
1. Due to their illiquidity, penny stocks tend to rise or fall within a matter of few seconds and minutes, hence, choose a broker who offers an online trading platform rather than only a call-and-trade facility.
2. It’s better to select the broker who offers both Depot (depository) and Nostro facilities. Depot is where the shares are kept after purchase in dematerialized form, whereas, Nostro account is the banking facility which allows instant transfer of funds to and from the account.
3. Traders should keep an eye on charges. Don’t be swayed by fancy advertisements. Ask the following questions to the broker before opening an account.
a. Know whether the brokerage is charged per order or per share and if there is any minimum brokerage.
b. Check if there are any additional charges for a large order size.
c. Are there any fees for maintaining the account every year? Are there any additional fees if you decide not to trade and your activity level drops?
d. Does your broker expect you to trade a certain minimum number of trades every quarter?
e. Does your broker allow short selling?
Depending on your account size, commitment to trading and expertise, clarify the above points before opening an account.
What are the advantages of trading in penny stocks?
Investors who are limited by their account size cannot afford to buy stocks quoting at high prices. If someone only has $5000 at his disposal, he can only buy 100 shares of a company quoting at $50. All his money will be blocked in a single trade; even if he finds opportunities elsewhere, he cannot invest due to limitation of his account size. Such investors can attempt to profit from their skill by trading penny stocks.
If the investor does his homework, there are instances where the stock prices have run up more than 30,000%. There are many examples where a penny stock company has progressed and its investors have benefitted handsomely.
The risks associated with penny stocks
However, it’s not all easy and rosy with penny stocks. Timothy Sykes, the successful penny-stock trader says that hype and big stories about the companies are usually false. According to him, 99% of the penny stock companies fail and picking the 1% winner is very difficult.
“You have to say no,” Sykes said.
“You can’t invest in penny stocks as if they were lotto tickets, but unfortunately that’s what most people do, and they lose again and again. Think of penny stocks as inmates in a prison that you can’t trust,” reports Market Watch.
Hence, investors should be careful before investing any money into penny stocks.
How should you allocate money to penny stocks?
The penny stock companies and their promoters use various social media advertising, newsletters, email campaigns, and other such methods to boost prices of the companies. Pump and dump is the infamous strategy used by the manipulators. If you want to avoid getting caught in such a scam, keep the following points in mind before investing in penny stocks.
1. Disregard stories of quick riches where traders are advertised to having made millions within a short span of time using penny stocks.
2. Do your own research on the available information about the stock before investing, rather than blindly allocating money on hot tips.
3. Never believe the management of the companies promising a bright future. Penny stocks are usually full of false stories, never accept their news at face value. Always do your background
research.
4. Don’t allocate all your money to a single stock, however good the story might sound to you.
5. Avoid short selling penny stocks, as even a single buyer can shoot prices off the roof and you will be left with huge losses.
6. Don’t expect to become rich by holding a single stock. Keep taking your profits when you have them.
Conclusion
Use only a small portion of your account size for trading in penny stocks. Understand the risks involved and make informed investments in the companies after thorough research. Know the charges associated with trading and choose the broker wisely.
Don’t expect to become rich overnight, do your own research and you might end up with healthy gains as you gain the expertise.