How to trade penny stocks

Jason BondJason Bond ·

Let’s face it, at one time or another, you’ve probably heard you should stay away from penny stocks. However, that shouldn’t be the case with all penny stocks. There are some you could trade and some you should stay away from. Picking the right penny stocks is what we do well at Jason Bond Picks Millionaire Roadmap. Now, learning how to trade penny stocks is a long process, and chances are you won’t become an overnight success. You need to keep your goals realistic in the penny stock game.

However, when you gain experience and learn from successful traders, you’ll learn to find the penny stocks that are poised to rise significantly. Let’s go over how to trade penny stocks and some of the key points you need to know before you even consider buying them.

Penny stocks defined

Now, there’s usually a negative connotation with penny stocks. You’ve probably heard you should stay away from them because a large portion are pump and dumps. People tend to think penny stocks are artificially pumped up through misleading catalysts like press releases. Thereafter, pumpers would just dump their shares on less-experienced traders. This is true to an extent, but you shouldn’t limit yourself to only a specific set of stocks.

The U.S. Securities and Exchange Commission (SEC) defines a penny stock as a security issued by a small company. These small companies could be micro- or small-caps trading for less than $5 per share. Just because penny stocks are small, relative to large caps, it doesn’t mean you shouldn’t trade or invest in them.

Examples of successful penny stocks

For example, Monster Beverage Corp (MNST) was once a penny stock. That’s right, the energy drink company known for supporting and sponsoring extreme sports like UFC, BMX, snowboarding, skateboarding and Bellator MMA was once trading less than $5 per share.

Here’s a look at the weekly chart of MNST, just to show you not all penny stocks are bad.

how to trade penny stocks - MNST

Although this is just one example, there’s a plethora of penny stocks that became successful, like BJ’s Restaurants (BJRI), Las Vegas Sands (LVS) and Bank of America (BAC). Keep in mind, LVS and BAC were trading under $5 during the financial crisis. However, again, it didn’t mean they’re bad companies.

Now, you need to learn to avoid some landmines when trading penny stocks. For the most part, you want to avoid penny stocks trading over-the-counter (OTC). Stocks listed on OTCQB or OTCQX do not have stringent listing requirements like Nasdaq or New York Stock Exchange (NYSE). We won’t get into all the details of listing requirements, just keep in mind you want to stay away from these stocks. That in mind, when you’re searching for penny stocks to trade, focus on those listed on Nasdaq or NYSE.

How to trade penny stocks

The greatest thing about penny stocks is the risk-reward. Basically, you don’t need to lay out a lot of capital to buy a penny stock, but you could potentially make outsized gains. Keep in mind, they could still be risky, and the odds could be stacked against you if you don’t know what you’re looking for.

One key component you need to take into account is the fact that there are penny stock promoters out their. They’ll typically send out an email or let you know their positions on social media. The one way to figure out whether a stock is a pump and dump is to see whether the promoter has a disclaimer and if the company is known or not. For example, if it’s a company you or your friends, or other traders haven’t heard of, you should just leave it alone.

Generally, you need a catalyst for a stock to move. It could be anything, a positive earnings announcement or press release, whatever the case may be, you need a catalyst for a stock to move. It could also be based on technical analysis too.

Filtering for penny stocks

You might be wondering, “Well, there are so many penny stocks out there, how do I find the ‘right’ one to trade?”

It’s not hard to do, and there are plenty of free tools for you to do that. Additionally, some trading platforms like E-Trade will let you scan for stocks.

For example, Finviz has a great screener.

All you have to go to the “Descriptive” tab and change the price to under $5.

how to trade penny stocks - FINVIZ

Source: Finviz

Now, I also added another filter here. I want to look at stocks that have closed up anywhere between 20% and 50%. This is all a part of our strategy for trading penny stocks, and our community is all about looking for moves like this, and we’ll use both catalysts and technical patterns to get into a trade.

You could also filter for sectors, technical patterns and fundamentals with Finviz. The best part is that it’s free. Again, some trading platforms will also let you build stock screeners and tailor them to your wants and needs.

You could also filter through the Exchanges too. For example, in this screener, I’m filtering for stocks either traded on Nasdaq, NYSE or NYSE American (AMEX). Again, it’s important to make sure the stock is not listed on OTC Markets when you’re learning how to trade penny stocks. Also, you want to make sure the company is “legit” and people actually know about them.

Once we’ve got that figured out, we’ll look through each of these and see if it fits our criteria.

Penny stocks example

Here’s a taste of what we do. Now, one stock that I found that could continue higher was Blue Apron (APRN). First off, this company is listed on NYSE and a small-cap stock. If you recall, you should try to stay away from stocks listed over the counter when you’re first starting out. This helps to mitigate some of the risk of getting caught in a pump and dump.

This stock came up on my screener, and it was trading below $5 at the time. This is what you should do as well when you’re learning how to trade penny stocks.

Here was my thought process:

APRN shares moved higher ahead of earnings after Mr. Wonderful, Kevin O’Leary picked it on CNBC as a takeover target.

Kevin O’Leary noted, “Having gotten close to that industry, getting involved with Plated, which was acquired by Albertsons … I thought, I know this space,” O’Leary said after the draft. “Blue Apron can’t survive on its own and it’ll get acquired, and I’m thinking the acquisition price could be between $4 and $5.”

The catalyst here was strong earnings and a statement from an influential investor.

Remember, we’re looking for realistic gains here. Chances are “legit” penny stocks won’t double overnight, unless it has a really strong positive catalyst. I took this trade and profited over 15% in just a few days. You might think you can’t make too much on a 15% move in a stock trading below $5, but once you position size properly, you could make some nice gains.

Here’s a look at the chart:

how to trade penny stocks - APRN

Not too shabby right?

If you take a more realistic approach to trading penny stocks, you should be able to generate some great returns.

You shouldn’t expect for every penny stock you get into to become a unicorn like Monster Beverage or catch a stock trading below $5 like Las Vegas Sands and seeing it double or triple in just a matter of months. It could happen, but it’s not too realistic.

The bottom line

When you’re learning how to trade penny stocks, there are few things you should keep in mind. The first thing you should do is figure out the stock’s listing exchange. If you hear some “stock guru” tell you about a penny stock trading on OTC Markets, just stay away at all costs. OTC Markets is like the wild wild west, and there aren’t as many listing requirements as NYSE, AMEX or Nasdaq.

Once you’ve done that, you could filter for stocks trading below $5 and then conduct some analysis. Thereafter, if you want to pull the trigger on the trade, you’ll need to find the catalyst and develop a trading plan.

For the most part, if it’s a liquid name and people have heard of it, you should be in the clear and would not be in an elaborate scheme. Thereafter, you would conduct your own due diligence and figure out if you think the stock could be a good long. Shorting penny stocks could be a dangerous game, and you want to stay away from that especially if you’re just learning about them.

You should have a good understanding that not all penny stocks are bad and you should just avoid the ones that could be pump and dumps. You’ll need to be realistic of the potential gains, only trade penny stocks listed on national exchanges (NYSE, AMEX, Nasdaq), screen for stocks, and then delve deeper into each stock on the filter. It’s going to take a lot of work to learn how to trade penny stocks, but if you keep at it, the reward could be substantial.

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 Jason Bond runs JasonBondPicks.com and is a swing trader of small-cap stocks.

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