When you see that the share price of penny stocks is expressed in a few dollars and sometimes even cents, the temptation to buy as many shares as possible is quite natural. But…is penny stock trading actually worthwhile?
For those who are not familiar with the term, penny stocks refer to company shares that cost under $5. They are the cheapest stocks traded in the stock market.
You may wonder why these shares are cheap – is it because the company offers low quality products and services? Not exactly! The reality is that the company is making its first steps into the market. The truth is that most of these companies will remain at this ‘first step’ level for their entire existence. It can be really hard for them to overcome the competition. However, most of the huge brand names you know today started from this place. Penny stock traders dream of discovering these treasures – small companies with very high potential in the future. Is it doable? Check out the following example :
Per this chart, nine small companies started their journey to conquer the market. This is represented on the first line (let’s say it’s the first level – a local market). From these nine companies, only five succeed to the next level – a regional level (the second line). Next, only three companies may reach the next level (i.e., national coverage). Finally, from these three companies, only one tends to dominate the majority of the market. This is WalMart, McDonalds, Microsoft, Google, and so on. Only one out of hundreds and thousands of small companies can hit the jackpot. Now, if you look only at the first level, can you tell which of them will succeed?
When trading penny stocks, your goal should not be to guess which of them will hit the jackpot, but to find which of them has the potential to get to the next level. This is very important, since penny stocks have the potential to double, triple, and even multiply their value by many times – and this is your chance to multiply your investment. Yet, don’t hurry! The risk of penny stocks dropping in price by multiple times is the same, so be careful. You should play with their volatility and learn how to manage risk.
Here are some tips for how to invest in penny stocks:
Understanding what you’re doing – First of all, you should have a basic understanding of how the stock market works. You should find the answers to questions like: What is a stock in general? How do companies increase their market capitalization and profits? How do traders speculate on price changes? And so on.
Choosing some potential sectors or penny stocks – Next, you should analyze a few penny stocks. They may be traded on the major stock exchanges, such as NASDAQ or NYSE, or may be traded Over-The-Counter (OTC) – which means a decentralized space that is not regulated and monitored. Dealing with penny stocks traded on regulated markets is a much less risky decision.
Choosing a broker and platform to trade on – This is one of the most important decisions, along with picking the penny stock you want to trade. The platform offers you the technical possibility to buy or sell the penny stock. It may be a direct investment in penny stocks or it may be a Contract for Difference (CFD) trading. In the latter case, you will not invest directly in penny stocks, but will trade their price. It is quite similar to betting on your favorite sports teams.
Make sure the platform you deal with is equipped with all the technical tools: charts, historical data, technical indicators, penny stock basic info, and so on. Don’t go for brokers that offer trading services over the phone! We live in a quite modern world, so it’s not a problem to find brokers with quality Internet-based platforms.
Choosing a specific strategy – Most penny stocks should be traded short-term, like keeping positions for some hours or days. This is why strategies with technical indicators or chart patterns can be suitable in your case. For example, some of the simplest strategies are trend-following systems that involve Moving Averages (MAs). You should read carefully the strategy conditions and test them on a demo account.
Picking the stocks and execute orders based on the selected strategy – Now, it’s time to trade! You should pick some penny stocks that you like and open positions on your platform. It is much better to choose penny stocks with high volume (meaning that they are liquid), with a decent P/E ratio, low debt-to-equity ratio, and high book-to-market value. Basically, it means that the penny stocks you choose should generate high revenue, don’t have much debt, and may present a good opportunity for acquisition by larger companies – which are good conditions for eventually hitting that coveted jackpot!
We hope the final step from this guide will be to enjoy your profits! On this note, please refer to additional articles on trading penny stocks to grasp a better understanding of the risks involved in penny stock trading.