How to start investing in penny stocks

Penny stocks are lower-value, often volatile assets with a lower price per share. As the name suggests, the term "penny stock" previously referred to a stock valued at less than $1, but now generally includes any share of stock valued at less than $5. Read on to learn how to get into penny stocks and decide which stocks to include in your portfolio. 

The basics of penny stock investing

Penny stock investing can be an enticing avenue for investors looking to capitalize on the rapid price movements of low-priced shares. However, you must consider all the characteristics that make purchasing penny stocks a risky endeavor. 

• Risk management: Penny stocks are known for their volatility, and prices fluctuate quickly due to several inherent characteristics of these shares, including small market capitalizations and lower liquidity. You can diversify your portfolio across different penny stocks and asset classes. Set clear entry and exit strategies and establish stop-loss orders to limit potential losses.
• Avoid the hype: Penny stocks often attract a fair share of promoters and touters who hype up the prospects of certain companies. Be cautious of unsolicited tips and "get rich quick" promises. Remember that the penny stock market is susceptible to pump-and-dump schemes, where manipulative traders artificially inflate a stock's price before selling off their holdings. Always rely on your research rather than solely on external recommendations. 
• Research well before you buy: Thorough research and due diligence are paramount before investing in penny stocks. Given the higher risks associated with these stocks, understanding the company's financials, business model and industry is crucial. 

Review the company's annual reports and press releases to gauge its financial health and growth prospects before purchasing shares. While this information might be more complex to locate due to the lower regulatory requirements of OTC exchanges, managing risk by scaling your investment proportional to public information available is important. Investigate the stock's trading history and any recent news or developments that could impact its price to determine an ideal entry and exit point. 

Penny stocks may require more dynamic market research and complex risk management strategies than blue-chip options or ETFs, which you'll need to factor into your trading strategy. 

OTC markets vs. major exchanges 

OTC markets provide a platform for trading securities that do not meet the listing requirements of major stock exchanges like the NYSE or the NASDAQ. OTC markets are a common place to buy and sell penny stocks, but they come with inherent additional risk due to the lower requirements. 

OTC markets have different tiers, with the OTCQX and OTCQB tiers considered more reputable and transparent than the pink sheets tier. Investors often prefer stocks listed on the OTCQX and OTCQB tiers due to stricter reporting and governance standards, but these exchanges still do not meet the same requirements as major exchanges. New investors still learning how to buy penny stocks will want to avoid pink sheets. 

Remember that gaining access to OTC exchanges is more difficult than major exchanges. Don't assume that every major broker will allow you to trade penny stocks, especially those off OTCQX and OTCQB tiers. Penny stocks on small exchanges also often have significantly lower liquidity and volatility than those on the NYSE or NASDAQ. This reinforces the idea that these stocks are most suitable as long-term investments. 

Compliance and disclosure requirements

The U.S. Securities and Exchange Commission (SEC) is the U.S. regulatory body that oversees the penny stock market. It controls the disclosure requirements that companies must submit to before entering each exchange. Penny stock companies, just like those with larger market capitalizations, must register their securities with the SEC and adhere to ongoing reporting obligations. 

For example, companies must prepare and publish audited financial statements, included in their annual reports and provide information on debt levels and cash flow. These reports are required because they provide insights into the company's finances, helping you to make more informed decisions as an investor — so use them.

While all companies are required to adhere to ongoing reporting requirements, major exchanges have stricter requirements for listed companies. For example, companies trading on exchanges like the NYSE must maintain minimum share prices and cash reserves. These requirements limit the companies listed on major exchanges to only higher-quality, comparably more stable investments. More lenient reporting requirements is one of the main factors that make penny stocks riskier — so consider this when evaluating investments. 

How to invest in penny stocks for beginners

Penny stocks are shares of stock issued by smaller companies with lower total market capitalizations. These shares are most notable for their volatility, which can cause the price to move by 100% or more in just a few days. While this might help you compound your initial investment, buying penny stocks is also exceptionally risky. If you're interested in learning about these volatile assets, read on to learn how to invest in penny stocks for beginners. 

There are several reasons why it's important to understand how to invest in penny stocks. For one, penny stocks can be a viable way to start in the stock market without investing much money. Penny stocks also tend to be much more volatile than larger stocks, so understanding how to trade them can be very beneficial. Finally, penny stocks can offer the potential for huge profits, so it's important to know how to buy and sell them to maximize your chances of success.

It's also important to know these steps to help prevent potentially huge losses. Do your own research and know when to sell and take profits.

Step 1: Do your research.

To make money from penny stocks, you need to do your research. There are several online resources, but one of the best ways to find good penny stocks is to use the MarketBeat stock screener.

A stock screener allows you to search for stocks that meet certain criteria. For example, you can search for stocks trading below $5, have a market capitalization of under $500 million, and have a beta of less than two.

Once you've found a list of penny stocks that meet your criteria, it's time to do your due diligence. This means reading the company's financial statements, looking for news stories about the company and speaking to experts in the field.

Step 2: Start small.

One of the best things about penny stocks is that you can start investing in them with a small amount of money. You can start with as little as $500 and still see a good return on your investment. This is a great way to get your feet wet without risking a lot of money in the investment world.

Another reason to start small when investing in penny stocks is that it allows you to diversify your portfolio. 

Investing in a variety of penny stocks can spread out your risk and increase your chances of seeing a profit. It's a great way to minimize your losses and maximize your gains.

Step 3: Have a plan.

Once you have researched and found a few penny stocks that interest you, create a plan for how to get into penny stocks. This plan should include how much money you are willing to invest, your goals and your exit strategy. It is also important to understand the risks of cheap penny stocks before investing any money.

When it comes to penny stocks, be patient to see any return on your investment. These stocks are notoriously volatile, so preparing for a roller coaster ride is important. The key to being patient with penny stocks is to have a clear investment plan and stick to it. This means knowing how much you are willing to invest, what you hope to gain from the investment and setting a timeframe for yourself.

Penny stocks can be tough to hold onto during a bear market, as investors generally dump their speculative investments (such as penny stocks) first during an economic downturn. This causes the value of these investments to plummet. The average bear market lasts for around a year before recovering, so be prepared to hold onto your penny stocks for a while if you don't want to take significant losses.

Step 4: Monitor and review your penny stock portfolio.

Regularly reviewing and adjusting your penny stock portfolio is essential to ensure it remains aligned with your financial goals and current level of risk tolerance. Market dynamics change rapidly, and penny stocks can be highly volatile. Regular assessment allows you to identify underperforming stocks, adjust your positions and capitalize on emerging opportunities. 

To review and adjust a stock portfolio, start by evaluating the performance of each stock in your portfolio, comparing it against your investment objectives and expectations. Next, assess your risk exposure to ensure it aligns with your risk tolerance and financial goals. Check the diversification of your holdings, making sure they span different stocks and industries to spread risk. Consider how current market conditions and economic trends may impact your portfolio. Additionally, be mindful of the potential tax consequences of making adjustments — you may want to consult with a tax profession before a major rebalancing. 

Investing in penny stocks is a high-risk, high-reward activity. Penny stocks have small market caps and low share prices, so there is room for significant profits and losses.

When you're done reading this article, you'll discover the components of a penny stock and how to start investing in penny stocks. We've also researched five of the best penny stocks to add to your portfolio.

Getting started with penny stock investing

Now that you understand the basic benefits and risks of penny stocks, you can get deeper into how to buy penny stocks on a technical level. Use the following basic steps when considering penny stock investments for the first time.

Set realistic goals 

Start by defining your investment goals. Are you looking for short-term gains, long-term growth or the potential for future dividend income? Determine the level of risk you're comfortable with and how much capital you can invest. Setting clear, achievable objectives will guide your decision-making process and ensure you exit these risky trades when you meet your goals. 

As a new investor learning to buy a penny stock, consider how each stock will fit into your portfolio long-term before trading. Penny stocks aren't suitable for new traders looking for a short-term trade, as their lower liquidity makes it exceptionally difficult to exit the trade at a particular price point. This reduces the predictability needed for successful day trading and scalping. 

Choose a reputable broker 

Choose a reputable brokerage that caters to penny stock investors by prioritizing user-friendly platforms, affordable commission rate and access to the markets where penny stocks are traded, including OTC markets and smaller exchanges. You may want to refine your trading strategy with a paper trading account or do your market research first to determine which tools and markets you need access to the most. 

Ensure that you have a reliable news source on hand 

Staying informed about market trends and developments is critical for successful penny stock investing. In addition to your broker's technical analysis trading tools, you may want to subscribe to a real-time third-party market newsfeed like MarketBeat’s headlines section to stay up-to-date on major market movements that could affect your investments. 

Consider stocks for long-term investment rather than active trading

While some investors are drawn to rapid trading and quick profits, approaching penny stocks with a long-term investment mindset is often more prudent. Focus on identifying companies with sound fundamentals and plenty of growth potential. This approach can help you build a more stable and resilient portfolio and resist the trappings of meme stocks and pump-and-dump schemes.

Building a penny stock portfolio

Penny stocks can be highly volatile assets, making diversifying your holdings important. Use these tips to diversify your penny stock portfolio and minimize losses. 

• Industry diversification: Invest in penny stocks across various industries. Avoid concentrating your investments in a single sector, as industry-specific risks can impact all stocks.
• Diversify across size: Consider a mix of small-cap, micro-cap and nano-cap stocks within the penny stock universe. These categories represent different risk and growth potential levels and can introduce stability to your holdings. 
• Perform risk analysis: Evaluate the risk associated with each penny stock you consider, looking at factors like financial stability, management quality and industry dynamics. Allocate a higher percentage of your portfolio to less risky stocks.

The most important thing to remember when investing in penny stocks is that these are riskier assets. Use penny stocks to complement a fully diversified portfolio of stocks, bonds, ETFs and other more stable assets to avoid risking an excessive percentage of your holdings. 

Trading strategies for penny stocks

Investors use two primary trading strategies when buying and selling penny stocks: long-term buying and holding and short-term trading. 

• Long-term: Long-term strategies for penny stocks involve buying and holding until the stock price has risen significantly in value. To identify long-term holds, focus on fundamental analysis and companies with a product likely to be in demand long-term. 
• Short-term: Short-term investors capitalize on penny stocks' volatility, buying into the most volatile stocks at lower prices and selling them when pricing rises. Short-term traders don't anticipate that the penny stocks they buy will likely be in business for years to come and will frequently switch between assets as data changes. Focus on daily average trading volume and price changes to identify stocks suitable for short-term trading. 

Thoroughly research each stock according to your investment strategy before buying and selling. Use stop-loss orders to prevent yourself from falling into the sunk-cost fallacy, which involves doubling down on bad positions to chase losses. Avoid making investment decisions based solely on hype or stock promotions, which you may see across social media. Penny stocks are often subject to market manipulation, so relying on sound research and analysis is essential.

Understand the risks

Are penny stocks worth it? Penny stocks are one of the most volatile and risky investments available. You can find these stocks on the over-the-counter (OTC) market. Penny stocks may seem tempting due to their low price point, but they are highly risky.

Here are some of the most significant risks associated with penny stocks:

• Lack of liquidity: One of the biggest risks of penny stocks is the lack of liquidity. Finding a buyer for your shares can be very difficult, especially if you need to sell quickly. This can lead to big losses if you cannot unload your shares before the price drops.
• Price manipulation: Another big risk with penny stocks is the potential for price manipulation. Because there is often very little trading activity in these stocks, it doesn't take much for a few large investors to drive the price artificially. It can lead to unsuspecting investors buying in at the top, only to see the price drop again.
• Lack of transparency: Another issue with penny stocks is the lack of transparency because many companies are not required to disclose their financial information to the public. It makes it very difficult to know what you're investing in, and it's one of the main reasons these stocks are so risky.
• No analyst coverage: Another thing that makes penny stocks so risky is the fact that there is often no analyst coverage. Nobody provides objective research on these stocks, which makes it harder to make informed investment decisions.
• Poor governance: Many penny stocks are also risky because they have poor governance. Many of these companies are poorly regulated, leading to various problems. For example, they may be victims of insider trading or other types of fraud.

Overall, penny stocks are a hazardous investment. If you're thinking about investing in these types of stocks, it's essential to be aware of the risks involved because there is a good chance that you could lose all of your investment.

Implement stop-loss orders to limit risk 

Protect your investments by implementing stop orders, which allow you to set predefined price levels at which you are willing to sell your shares to limit potential losses. These orders are an essential risk management tool when dealing with the high volatility of penny stocks, which can quickly liquidate value. Setting stop-loss orders prevents you from waking up one day to find that a penny stock you've invested heavily in is now worthless, leaving your portfolio with a significant loss. 

A dynamic investment strategy can help you limit the potential for fast loss when investing in volatile assets like penny stocks. Use the following tips to identify viable investments and filter out companies less likely to withstand the test of time. 

• Diversification: One of the most effective ways to manage risk is through diversification. Spread your investments across different penny stocks, industries and asset classes. By doing so, you reduce your exposure to the potential pitfalls of a single stock or sector.
• Research and due diligence: Realistic expectations and plenty of research is your best defense against risk. Investigate the company's financials and closely examine how debt levels change. A solid understanding of the company's fundamentals can help you make informed decisions about long-term portfolio additions. 
• Identify and avoid pump-and-dump schemes: Be vigilant and watch out for penny stock pump-and-dump schemes, where manipulative traders artificially inflate the stock's price before selling off their holdings. Be very wary of any stock with excessive promotion or that you cannot find financial information on. 

Choosing the right penny stocks

Being picky with your penny stock investments is crucial to responsible trading. Be sure to investigate at least the following company aspects before deciding to buy penny stocks. 

• Company research: Thorough research is the basis of all successful penny stock trades. Pull financial reports like the company’s most recent balance sheet to assess its financial health, revenue trends, debt levels and growth prospects. Penny stocks often represent smaller companies, meaning financial documents and analysis might not be as plentiful as with larger options. 
• Avoid piling in on overhyped companies: When choosing which penny stocks to buy, it's essential to recognize that the often-impressive 30% returns they can offer may vanish just as swiftly as they came. The volatility of the penny stock market means that price movements can change direction rapidly, so it's essential to avoid buying into stocks with temporary hype. Investors who are slow to react may find themselves in a situation where they must sell their positions to minimize losses.
• Take a long position: While there is no lack of short-term trading strategies that rely on penny stocks, these strategies are exceptionally risky — especially for new investors. Take a long position and rely primarily on fundamental analysis when choosing companies to add to your portfolio. 

Paper trading can be a useful resource for those learning to purchase penny stocks for the first time. You might even want to seek out a broker offering dummy account features if you'd like to monitor pricing before determining an appropriate entry and exit point. 

The basic process of buying and selling penny stocks is the same as investing in major shares. Order types and the concept of protecting your money through diversification and dynamic company research are also the same. Suppose you're just learning how to buy and sell shares of stock. In that case, the higher liquidity and lower daily price movements of companies with larger market capitalizations can often be a better place to begin. 

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