Penny stock trading remains a popular strategy choice, and it can yield outsized returns for seasoned traders. The penny stock market is not for beginners, as it features many frauds, especially pump-and-dump schemes perpetrated by investment groups, social trading outlets, and newsletter providers.
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There is also a general misunderstanding of what qualifies as a penny stock. Let us begin with the proper definition and then discuss how to start with penny stock trading and what to avoid.
What is a Penny Stock?
The NASDAQ Capital Market, specifically designed for early-stage and smaller companies, often sees listings of stocks that may fall under the penny stock category due to their lower share prices. However, it's important to note that the majority of what are traditionally considered penny stocks typically trade OTC rather than on major exchanges.
Where Do Penny Stocks Trade?
Other avenues exist, like the NASDAQ Capital Market, the NYSE American, the TSVX in Canada, the Euronext Access and Euronext Growth across the Benelux countries and Portugal in the EU, and most UK-listed companies, with the FTSE AIM Market of particular interest.
Most equity markets globally list penny stocks, but the challenge is to find a broker granting access to penny stock markets, where the choice is limited and often requires full-commission brokers at well-established institutions or leading international brokers. Some online brokers offer penny stocks listed on major exchanges. Most online retail brokers focus on blue-chip stocks, as they lack the necessary infrastructure to cater to lower volume penny stock traders.
What Should Traders Know Before Trading Penny Stocks?
Trading penny stocks listed on any market other than the OTC Markets Group follows the same approach as trading other equities, with one exception.
The exception for trading penny stocks is:
- Penny stocks can move violently based on the impact of news releases and earnings reports.
While most established equities tend to rally or sell off during a material report with prices moving through the prices levels as traders adjust positions, penny stocks can ‘price gap’ by large amounts. The reason is the thin order book trading volume on many penny stocks where quotes can disappear completely due to lack of buyers and sellers.
Penny stock traders on the OTC Markets Group should also consider the following:
- Pump-and-dump schemes
- Quote stuffing by market makers
- High trading fees
- Thin trading volumes
- Erratic price action
- Trading days without a single transaction
How to Avoid the Worst Penny Stocks?
Knowing how to avoid potential pump-and-dump schemes and other frauds remains an essential skill for penny stock traders.
Here are some tips on how to avoid the worst penny stocks:
- On the OTC Markets Group, research stocks listed under OTCQX and OTCQB, where almost 2,000 assets trade
- Avoid companies with thin trading volumes and frequent trading sessions without transactions.
- Stay clear of companies quoted below a certain threshold, particularly below $0.10 per share.
- Do not trade companies without revenues.
- Skip companies who do not voluntarily file audited statements with their regulator, like the EDGAR filing system of the SEC in the US
- Ignore penny stocks trending on social media.
- Conduct proper due diligence and understand why a company trades at the quoted price despite having a product or service with paying clients.
How to Trade Penny Stocks
The first step of trading penny stocks is education, followed by experience in trading non-penny stocks and understanding how earnings releases and corporate reports can impact price action.
Penny stock trading is like the meme stock craze that began dominating select equities during the Covid-19 pandemic, where a group of investors hypes beaten-down names on social media. Retail traders pile into those stocks, trading against professionals, causing massive rallies and sell-offs and sometimes resulting in short squeezes.
Here are some tips on penny stock trading:
- Find a broker offering penny stocks at reasonable fees, as some may charge extremely high commissions for penny stock trading.
- Avoid penny stocks trending on social media, which is the investing equivalent to playing musical chairs.
- Trade penny stocks with a product or service that requires scaling rather than an idea that searches for a market to sell too.
- Trade penny stocks with regulatory filings
Penny stock trading can be rewarding for seasoned traders. Some trade exclusively penny stocks for a living and researching penny stocks also rewards traders with insight into innovative products and services, especially in technology, pharmaceuticals, biotechnology, security, and defense. While penny stock trading may yield high rewards, the downsides can devastate portfolios that are too heavily weighted with risky assets, and penny stock trading is not for beginners.
How do I start trading in penny stocks?
Penny stock traders should start with education before opening and finding a trading account with a broker offering penny stocks. The approach to trading penny stocks is identical to other assets. The core aspects are research, analysis, risk management, position sizing, and trade management.
Can you still trade penny stocks?
Traders can trade penny stocks listed on many global exchanges. The OTC Markets Group in the US quotes traditional penny stocks, but any company trading below $5.00 per share qualifies, providing traders with plenty of trading opportunities.
Can you trade US penny stocks in the UK?
The AIM market in the UK is where traders will find most US-headquartered penny stocks. The UK equity market quotation is in pence rather than pounds, making every UK-listed company a penny stock.
What are the best penny stocks to trade?
The best penny stocks to trade are the most liquid ones and the ones with an actual business model that can or is generating revenue.
How do I trade penny stocks in the UK?
Penny stock traders in the UK usually opt for spread betting accounts over CFDs, as the former is a tax-free derivative.