How to Get Started in Penny Stocks

Penny stack sitting on stock market data
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If you want to invest in stocks but don't want to risk a lot of money, penny stocks let you get started quickly and simply. There are risks with penny stocks, as with any investment. Be sure you understand them before you begin.

Stock market investments are shares of ownership in an underlying company. That means it pays to look for companies that operate in a way that creates increasing value over time. When those companies do well by increasing revenues, capturing more market share, or growing in size, their share price often follows suit by increasing as well. Success with penny stocks means looking for high-quality companies like these.

If you find a high-quality company still trading at low prices, you can multiply your investment dollars when the shares move higher. But if the price of your pick plummets, the company goes under, or you can't find a buyer when you're ready to sell, that investment sours quickly.

Learn more about investing in penny stocks.

Key Takeaways

  • While some penny stocks may be traded on major exchanges, others are traded over the counter. This means they have less volume.
  • Less volume and liquidity translates to less control over the prices you use to buy and sell the penny stocks. It also provides more volatility that can be profitable for traders.
  • For those who specialize in researching business fundamentals more than trading, penny stocks allow investors to buy valuable operations at extremely low prices.
  • As with any type of trading, it's best to practice your penny stock strategy with paper trading before risking real money.

What Are Penny Stocks?

Investing in penny stocks is similar to the process of buying stock in a massive company such as IBM or Google. The difference is the share price is much lower and usually much more volatile. Often, the company which the penny stock represents is much smaller, newer, or yet undiscovered by other investors.

In the U.S., penny stocks are defined as stock shares that trade for $5 each or less.

They're generally thinly traded. This means they are traded infrequently and it's difficult to accurately price them. This can also make them difficult to sell.

Note

Sometimes unexpected companies can fit broadly into the penny-stock category. Auto giant Ford Motor Company, for instance, was trading below $2 per share after the 2008 financial crisis.

Where Are Penny Stocks Traded?

Some low-priced stocks might be traded on major exchanges. These could include the New York Stock Exchange (NYSE), NYSE American (formerly the American Stock Exchange), and Nasdaq. However, penny stocks frequently are traded over-the-counter (OTC) in markets such as OTCQX, OTCQB, and OTC Pink.

Quotes for stocks trading in these marketplaces are called "pink sheets." That's because their listings were once printed on pink paper. However, they are now strictly electronic.

Pink sheet stocks are typically penny stocks trading at a low price. Or they may be stocks from companies that prefer to avoid the financial disclosures required by the major exchanges. The lack of financial data when trading over the counter can make it difficult to figure out the true value of a stock.

Potential of Scams With Penny Stocks

People who have been burned by scams and those who were fooled into purchasing low-quality companies rightly have bad things to say about penny stocks. The thinly traded nature of most penny stock companies affords dishonest players the opportunity to try to profit by manipulating stock prices.

People vulnerable to such scams can get taken in by the dishonest hype a scammer gives them about a certain company. This can happen via an online forum or a newsletter. Believing the hype, the investor buys the stock. They don't know that it's worthless.

It is never a good idea to buy a penny stock that has been heavily promoted. No high-quality company needs a promoter to drive its stock price higher. Companies that are worth your investment will increase in size and price on their own.

How Can You Reduce Your Risk?

Penny stocks are risky purchases. You must take that risk into account when deciding to purchase them. It can help to learn how to research companies and focus on ones with high-quality operations. That way, you can improve your chances of turning a small investment into something much more significant.

Protect yourself by avoiding free stock picks, heavily promoted stock tips, and the less-regulated OTC markets. Find out everything you can about a company's financial position, its operations, and its trading history. Only then should you buy a share of its stock.

Practice Trading on Paper First

It pays to learn how to invest properly, no matter how long it takes. Before you begin investing in penny stocks, test out your strategy on paper. Keep track of real stock movements with imaginary money investments. Then, see how you would have done if you had traded actual dollars.

Practice until your imaginary investments are successful. When you're confident in your strategy, then look for good penny stock companies to buy shares in real dollars.

Tip

Good penny stock companies are those that are low-priced and are turning the corner and gaining momentum.

With diligence and research, you'll learn to find companies with shares that will rise. And you may even earn a profit in the process.