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. 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.
What Are Penny 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.
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.
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 stock, just to show you not all penny stocks are bad.
Although this is just one example, there are 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.
When you’re learning how to trade penny stocks, you need to understand how to deal with risk. Risk management is one of the keys to success when you’re trading penny stocks. Penny stocks are cheap and could have high potential returns. Like always, the higher the reward, the greater the risk. It’s probable to profit if you understand how to trade penny stocks, but when you don’t the odds are stacked against you.
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.
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.
Do Your Own Due Diligence
No matter what stock you’re trading, you should always conduct your own due diligence. If you want to learn how to trade penny stocks, this is an important factor to take into account. You need to be prepared, and that may mean knowing specific technical levels and news. Before you even make a trade, you need to know the facts. In turn, this should help you in making better trading decisions. You don’t want to randomly buy a penny stock just because someone told you it was up 100% and could run higher. You’ll just be chasing there.
For example, if you see a stock up significantly, look at the facts and see if the move was justified. However, you wouldn’t chase the stock up. Wait for a pull back and try to participate in the next move higher.
How to Trade Penny Stocks – Dealing With Risk
One key component you need to take into account is the fact that there are penny stock promoters out there. They’ll typically send out an email or let you know their positions on social media. 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.
We’ve all seen it before. A bunch of people on social media talking about a penny stock success story. Heck, you may have even gotten an email about a penny stock success story. However, you can’t just trust people on social media or someone sending you an email about a penny stock that just doubled overnight. You should never trust a random person on social media telling you to buy a stock. They could be part of a pump-and-dump scheme. Basically, they may just want people to drive the stock up, only so they could sell it at a higher price.
When you’re learning how to trade penny stocks, you need to focus on the process first. You shouldn’t look to hit a home run on your first trade. Rather, you want to learn the basics and the trading process when you’re looking to trade penny stocks.
Using Stop Losses
When you’re first learning how to trade penny stocks, stop-losses could be extremely helpful. Basically, you could set a price at which you would sell out of your position if it’s moving against you. Many beginner traders don’t use stop-loss orders, and it often hurts their trading account. For example, if you think a penny stock could rise from $4 to $4.75, you should risk no more than 50 cents on the trade. Ideally, you want a risk-reward ratio greater than 1-to-2.
In other words, for every $1 you risk, you should look to make at least $2. When you’re first starting out to trade penny stocks, you might want to risk less and look for higher-risk reward ratios.
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.
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:
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, manage risk, 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.
Jason Bond runs JasonBondTraining.com and is a swing trader of small-cap stocks.