While penny stocks are the riskiest types of stocks to own or trade, they can also provide cheap entries and outsized profit potential if managed prudently. The internet and social media is riddled with hype and claims of big profits to be made from trading and investing in these stocks. For those willing to speculate in the murky world of penny stocks with pure risk capital, here’s some tips and ideas.
What Is A Penny Stock?
The term penny stock is usually referred to stocks that are priced under or around $1.00. The underlying companies tend to have operating issues and problems. Despite the hype, very few penny stocks are going to be “diamonds in the rough” that are undiscovered by the markets. In all reality, penny stocks are cheap for a reason. They have “fleas”.
These stocks may be listed on national exchanges like the NYSE, NASDAQ and AMEX or the OTC and Pink Sheets. The latter two tend to have much less liquidity as as many brokers don’t allow trading in this exchanges. Keep in mind, there is a big difference as to which exchange a penny stock is listed on. It’s preferable to stick to penny stocks listed on national exchanges (NYSE, NASDAQ, AMEX) versus the OTC and Pink Sheets for reasons of liquidity.
Caveat: Penny Stocks are RISKY! This can’t be understated. You can lose all or most of your investment in penny stocks.
How To Find Penny Stocks
For those who are fully aware of and willing to accept the risks of total loss, there’s various resources to find penny stocks of interest:
Scanners on your trading platform are the most “objective” way to find penny stocks. Configuring your setting by price, volume and exchange can help to find cheap stocks with heavy volume and large gaps to watch. Free online scanners like Finviz.com or OTCMarkets.com are also reliable since they filter by purely price, volume and percentage price change.
Social media sites like Twitter.com, Stocktwits.com and message boards can provide ideas but keep in mind that every post must be taken with a grain of salt. It’s musical chairs so you must be able to gauge where in the sequence you would be taking an entry if you play. Articles can also be linked on these sites, which can also provide some color on what is triggering the price action.
Some of these are more reliable than others and always take any information even if it’s a press release from the company with a grain of salt. Penny stocks are guilty until proven innocent.
Research The Penny Stocks You Find
When you find penny stocks that are compelling, make sure you research what fundamentals are available. If the stock is gapped up huge, find the news catalyst, theme and peers to compare with. Do the extra legwork to research the underlying company so that you aren’t a deer in the headlights and don’t become a bagholder by circumstance. The goal of the research is to understand the narrative that is causing the near-term positive sentiment which is affecting the price.
Penny Stock Trading/Investing Tips
Here’s some things to keep in mind when trading/investing in penny stocks. Beginners really need to practice on a simulator. Let’s be real here, most penny stock traders and investors play these low-priced stocks due to their small account sizes and limited capital. Penny stocks are cheap and most of the traders have small accounts swinging for homeruns. Unfortunately, swinging for homeruns results in more strike outs and account implosions. With that in mind, here’s some tips:
Penny Stock Are Cheap For A Reason
As much as you may try to justify a penny stock investment, it’s cheap because it has problems. Perhaps, there’s catalysts on the horizon that can improve the situation, but the market views it as a dud for now. Be skeptical and only when the narrative can overcome your skepticism should you consider investing. Sometimes (very few) there are extenuating circumstances, or a turnaround is underway (IE: new management, pipeline, financing, theme) that the market has not priced in.
Don’t Buy The Hype
Press releases and social media can be a catalyst that gets prices moving. Don’t believe the hype and don’t chase the hype. You should be able to shape your own narrative objectively with both the bullish and bearish case. Think in third-person and game the reaction from the surface level but don’t subscribe to the hype. Stick to the price action alone and use charts to identify trend, support and resistance levels. It’s also prudent to be aware of the historical volume. If a penny stock normally trades less than 100,000 shares a day and it’s trading 20 million shares on a particular day, then make sure you are aware of the potential for liquidity to dry up fast when volume returns to historical averages.
Look At The Financials
Perform a basic fundamental analysis of the financials. Is the company profitable? Does it have heavy debt loads? Is there actual cash in the bank? Why is the stock down or up on the session? Is there a particular theme or catalyst causing a large price move? These are just the basic questions to ask and you should have the answers even before you take a position.
Examine SEC Filings
This can be tricky with penny stocks. If the stock is listed on a major exchange, then you should be able to access 10-Q and 8-K filings. Unfortunately, stocks listed on OTC and Pink Sheets may have outdated filings and little news. For this reason, it’s prudent to stick to penny stocks that are listed on a major exchange. Look for any dilution through stock offerings/warrants and/or insider selling (Form-144 and Form-4) or insider buying.
Time Your Entries
As a rule of thumb, try not to chase entries. Be aware of the trend and support levels and place your bids to get in on pullbacks. If you are playing the momentum, make sure the trend is on your side. Watch out for falling volume. Charts are critical for this.
Remember That Cheap Isn’t Always Cheap
Just because a stock is priced cheap, it doesn’t mean there is value. Penny stocks are cheap for a reason, they have problems. When it comes to price action, think in terms of percentages. A $0.10 price move on a $1.00 stock may seem small, but it’s a 10% price swing. This is the equivalent of a $400 price stock moving $40. The percentage price move is most important. Be aware of the slippage with the spreads as well. If that $1.00 stock has $0.05 spreads, that’s a 5% spread from the get-go. Therefore, it’s important plan your entries with limit orders preferably on the pullbacks to support levels.