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June 1, 2018

pile of pennies

What are Penny Stocks?

Penny stocks (also called micro-cap stocks) are stocks with extraordinarily low stock prices. There isn't a firm, SEC-approved definition of a price limit for penny stocks, but typically anything from $5 and less is looked at as a penny stock. Penny stock trading can be a risky proposition. There are really two types of penny stocks: real companies and scams.

Real Companies

CitiBank glass buildingRemember, stock price is tied to the market's expectation of future performance. If the stock price has fallen very low the market is not expecting the company to be around much longer. Yet if the company is a real company with real revenues, expenses, and earnings there is a chance it can return to its former glory.

A good example of this is Citigroup during the financial crisis. The stock had been cruising around $50 per share and crashed down as low as $0.97 per share. The market thought Citigroup was going to disappear, but if you had taken the risk you would have been rewarded handsomely. Shares are currently at $47. Citigroup is an example of a real company facing serious headwinds. Risky, but a real company.

Pump and Dump Scams

Truck Dumping Dirt into large pileThe other type of penny stock are scams tied to pump and dump schemes. These stocks often don't trade on the major exchanges and are either traded on the over-the-counter bulletin board (OTCBB) or via pink sheets. Pink sheets are compiled in a daily publication by the National Quotation Bureau and the shares used to be physically traded over pink pieces of paper. Pink sheets are not on a stock exchange and do not need to meet minimum requirements or file with the Securities and Exchange Commission (SEC).

Editor's Resource: Best Penny Stock Newsletters

As you might expect this type of penny stock is at significant risk to price manipulation and pump-and-dump schemes. Pump-and-dump schemes are where someone buys a bunch of shares in a penny stock then encourages others to invest so the price goes up; that's the pumping part.

Once the shares have risen enough to make a tidy profit the pumper then dumps the shares and sells everything he has at the higher price to all those other investors that were drawn in by the encouragement of the pumper.

Defend Yourself from the Risks

triangular sign with exclamation markThat being said, there is definitely money to be made with penny stocks. I just want to provide fair warning: this isn't your normal day trading of stocks. This is a risky operation that is fraught with hidden agendas. Coming into the situation with this knowledge allows you to prepare how to defend yourself from the risks while still working your way to a profit. Check out our What Are Penny Stocks article for even more information and our homepage for more information on Personal Income.

How to Invest in Penny Stocks

  • Step #1:

    First, you need a broker that has inexpensive trading fees and extremely fast execution. You will be trading a lot so high fees can ruin your profits. Slow trading execution times can result in massive losses due to the fluctuations in the stock price while you wait. You put in an order to buy or sell and it takes a while to go through, meanwhile the stock moves in the opposite direction you want it to and you end up losing a ton of money. In this article, we've reviewed the best brokers for penny stocks to help you get on your way.

  • Step #2:

    Research written on paper looked at through magnifying glassNext, you start doing research on companies to potentially invest in. This requires in-depth analysis so you can avoid the pump-and-dump schemes and focus on real companies. You'll need to come up with your own criteria as to what makes a stock attractive, but you can't do a simple search for low stock prices and just start flinging money at random penny stocks. Check out our analysis and reviews of the best penny stocks to buy now.

  • Step #3:

    Once you invest in shares you have to watch them like a hawk. This is not a buy-and-hold philosophy. Penny stock traders often hold shares for less than a day — or even trading in and out of the shares multiple times per day. You have to be able to dedicate the time to being aware of the fluctuations in the price so you can exit at a profitable moment.
    Check out our more detailed article on how to trade penny stocks.

4 Ways to Find Top Penny Stocks

Here are four ways you can narrow down your search for the right penny stock:

  1. Subscribing to Free Penny Stock Newsletters

    Drawing of envelopeThere are a multitude of penny stock newsletters available. They have various criteria and many of them are plying shares in order to pump up the price so you must be cautious. The SEC requires the newsletters to have a disclaimer at the bottom of the email as to why the company is being promoted.

    More often than not it is because of the firm's investors we can to drum up support for the stock price. There's nothing inherently wrong with that — the good companies are trying to ‘graduate' off of the OTCBB and pink sheets to a more reputable exchange like the NYSE or Nasdaq, but you must know the motivations behind the newsletter.

  2. Paid Penny Stock Services

    Another option is to pay for a membership to a penny stock alert website. These websites charge you and provide the analysis and alerts of potential investment options. Again, there's nothing wrong with outsourcing the work but you must know the reputation of the firm and the motivations behind the alert. For analysis of some the best alert programs, click here.

  3. Penny Stock Gurus like Timothy Sykes or Jason Bond

    • Gold guru statueTimothy Sykes turned $12,000 of bar mitzvah money into $4 million over several years… just trading penny stocks! He has a website and newsletter that promises to train you in the method he used so you can replicate his success.
    • Jason Bond Picks is another website that focuses on training you on how to profit from swing picks of stocks valued at $10 or less.
    • James Connelly has developed a program called Prophet in which he shares his secrets and tips for turning a $1,000 investment into 6 figures in only a few trades.
    • Steve LeBlanc is a very successful penny stock investor that has developed the PennyPro program which focuses on small traders looking to bulk up their portfolio. It includes alerts, watch lists, newsletters and more.
    • Created by John Bell, the Golden Penny Stock Millionaires program focuses on the timing of buying and selling penny stocks. One of its advantages is that it isn't paid to promote any specific companies.
    • Nathan Gold is a math whiz, and he's developed the Penny Stock Egghead system to use those talents to pick great stocks.

    These aren't the only experts with newsletters and services, but they are some of the most prominent ones available to learn from.

  4. Learning the Fundamentals and Technical Analysis

    Alternatively you can learn all of the fundamentals, technical analysis, and other strategies that are the foundation behind all of the experts' success. This is by far the hardest route — no one is doing the work for you, no one is providing you a list of stocks to pick from — but can be the most rewarding as you come up with your own unique strategy.

Buy and Sell

You buy at a lower price and sell at a higher price. Buying shares at $1 and selling them at $1.25 in a few hours or days is a 25% profit. If you bought 1,000 shares you would profit $250 before taking brokerage trade commissions into account. This method is hoping for the stock price to go up.

Short and Buy Back

red line graph of market fluctuationThe opposite of buy and sell: you want the stock price to go down. When you short a stock you borrow shares from your brokerage firm at the current price. In the future at hopefully a lower price you buy shares and return the shares you had to the broker. A stock starting at $1.25 that you short down to $1 would result in $0.25 profit per share.

There is more risk on shorting stocks because the downside is unlimited. If you short 1,000 shares at $1.25 and they skyrocket to $10 per share you've just lost $8,750. On the other hand if you had bought shares in hopes of them going up and they plummet to $0 you would only lose $1.25 per share (for a total loss of $1,250).

For more info on making money trading penny stocks, check out our top 10 rules by clicking here.

Final Thoughts

the thinker bustPenny stock trading is definitely not for everyone. For those who are okay with riskier investments and don't mind losing your shirt a few times before making any money, give penny stock trading a try. Make sure you tiptoe into it and invest small amounts of money before scaling up your investments. For more information on personal income investing, check out our homepage.

About the author 


Tom is a former accountant turned entrepreneur. He is not a financial adviser but does tend to give a lot of financial advice to his friends and colleagues. He currently runs a small online venture and blogs about his research and experiences.

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