How to Invest in Penny Stocks
Investors who are just getting started may be wondering how to invest in penny stocks. But penny stocks aren’t bought by only beginners. In fact, experienced stock traders, corporate insiders and hedge funds (to name a few) all invest in penny stocks.
Understanding Penny Stocks
When you hear the term “penny stocks,” many things may come to mind… including pink sheets, cheap stocks and risky investments. The truth is, none of these identifiers is completely incorrect. Trading penny stocks comes with a large amount of uncertainty. Penny stocks typically come from microcaps or small companies that struggle with liquidity. On a daily or weekly basis, not many shares change hands.
Historically, penny stocks were stocks that traded for less than $1 per share. However, that definition was expanded by the Securities and Exchange Commission (SEC). It now includes any stocks that trade for less than $5 per share.
The 2013 film The Wolf of Wall Street details infamous stockbroker Jordan Belfort’s rise and eventual fall. His crimes included stock market manipulation and running a boiler room as part of a penny stock scam. Belfort traded thousands of penny stocks that were not listed on any of the major stock exchanges.
Even though penny stocks have been the subject of many financial scams, they can still be beneficial for investors looking to buy shares at a lower price. And if a company grows, it can gain access to a larger marketplace listing. Additionally, penny stocks allow small companies greater access to public funding.
How to Invest in Penny Stocks
Depending on which brokerage platform you use, the process could vary slightly, but it should look something like this:
- Add Funds: Send funds to your brokerage account.
- Pick Stocks: Identify potential penny stocks to buy.
- Specify Order Type: You can execute a market order, limit order, stop loss order or stop limit order.
- Quantity: Select the number of shares you want to buy (keep in mind that for stocks under $1, brokerages might have a minimum of 100 shares required for purchases).
- Extended Hours: Many penny stocks trade after-hours, so you’ll need to specify when to trade.
- Review Your Order: Read a summary of your order in full detail and make any necessary adjustments before submission.
- Submit: Confirm your order by clicking the “submit,” “trade” or “buy” button.
And that’s it! Trading stocks is much easier now than in previous decades. If you’re just getting started, try downloading Robinhood or Webull. After filling out a brief application, you should be approved in no time (usually 24 hours) and can begin trading.
Anyone looking to invest in penny stocks will want to review the brokerage fee structures. Some brokers receive a per-share commission, which could be quite sizable for investors buying large quantities at a time. With this in mind, you might want to look for brokers with a flat fee structure.
If you’re charged a fee every time you buy and every time you sell, you could end up losing more of your profits. This is important to keep in mind. Lower broker fees are what every investor hopes for, but they are increasingly important in the area of penny stocks.
OTC vs. Larger Exchanges
Let’s say you find a penny stock recommendation that seems promising. You then log in to your account on your desktop or mobile brokerage app, only to find that the stock isn’t available to trade. This can happen often.
Today penny stock markets are less regulated than the big exchanges. Many of the recommendations you can find online are over-the-counter (OTC) penny stocks. They don’t often trade on the NYSE.
OTC penny stocks are primarily traded on the OTC Bulletin Board (OTCBB). Many major brokerages offer OTC penny stock trading. However, it’s important to keep in mind that OTC exchanges are not required to disclose the same amount of company information as the larger exchanges. This can include accounting statements and credit reports, as well as other pertinent information investors should know to make informed decisions.
There are different minimum standards that need to be met to stay on the OTC exchanges. The high standards of major exchanges act as reassurance for investors and without them, investing becomes more risky.
OTC dealers act as market makers and can influence share prices, depending on the client or customer demand. They can also withdraw from market making at any time, creating a void in liquidity.
In contrast to OTC markets, larger exchanges promote better buyer and seller transparency.
As previously mentioned, larger exchange-listed penny stocks have to meet higher listing requirements, such as paying higher entry and annual listing fees. These companies must also reach minimums for equity and share price, as well as number of shareholders.
For transparency reasons alone, it may be best to buy penny stocks on larger exchanges as opposed to their OTC counterparts.