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What Are Penny Stocks & How to Trade Them?

Donny Gamble
February 26, 2022
penny stock trading
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Everyone wants to get rich, and you might have read or heard stories about some people getting rich off of penny stocks. Has it happened? Yes. Is it likely to happen? No, otherwise everyone would be doing it.

Penny stock trading has a strategy to it, it has rules you have to follow, and you run a severely high risk for all assets you put on the line, and I mean all assets. So what’s the appeal? Why do people still trade penny stocks?

We’ll explain what they are, how you can trade them, their legality, and whether or not it’s a good idea for you to get started with penny stocks right now.

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So What Are Penny Stocks?

Penny stocks are described by the SEC as follows:

“Penny stocks are low-priced shares of small companies. Penny stocks may trade infrequently – which means that it may be difficult to sell penny stock shares once you have them. Because it may also be difficult to find quotations for penny stocks, they may be impossible to accurately price.”

This is basically what it all translates to:

  • NYSE Penny Stock: A company releases a stock or security that is valued under $5.00 and is listed on the New York Stock Exchange. It’s under SEC ruling just like the big stocks are, but doesn’t possess enough value to really be a contender.
  • OTC Penny Stock: A company releases a stock or security with little to no regulation by the SEC. These can evaporate overnight, be valued at a literal penny, and have a high turnover rate. The OTC marketplace is completely separate from the NYSE.

If you have ten dollars to burn and you want to invest in penny stocks, you could own 1,000 shares of a small no-name company right now. Just keep in mind that there are risks, which we’ll go over in just a moment.

Are Penny Stocks Legal to Trade?

Yes, penny stocks are legal to trade through both markets that we mentioned. However, legal doesn’t mean regulated. OTC penny stocks are sometimes manipulated due to the lack of information that the SEC requires on the individual company.

A company could be called 123 Inc., and build what appears to be a business, but is actually a load of hollow words and facades. Brokers then say “Hey, I know this stock that’s going to take off,” and then individuals pour thousands of dollars into these stocks.

The company makes money from the stocks, the brokers make their commission, and then the company disappears overnight without a trace. 123 Inc. is no longer in operation, and because of the SEC laws, you have no way of getting your investment back.

So penny stocks can be manipulated, although there are plenty of guides and educational content around that help you decide whether a penny stock is worth the risk or not. 

It’s not a foolproof strategy, but in time it has helped people to weed out the false companies and save their money.  Penny stocks on both marketplaces are legal to trade and you won’t get in trouble for trading them at all.

Gains still need to be counted as income even if they are from the OTC marketplace.

Why Aren’t All Penny Stocks on the NYSE?

Some stocks are traded through the OCT Bulletin Board (OTCBB). These are generally companies that don’t have the ability to register an IPO on the NYSE, or don’t have enough market growth to make it worth their while to post on the NYSE.

The U.S. Security & Exchange Commission, better known as the SEC, are the ones who regulate stocks on the New York Stock Exchange. They have filing requirements that companies must meet if they want to be listed on the NYSE.

Companies that are too small or too unorganized to properly do this (and to be fair, some just lack the know-how or ability as it’s not critical in the early stages of their business) will still want to see just how much interest is generated in their company’s value.

In some instances, this leads to a lot of stocks being purchased, and the ticket eventually moves to the NYSE as they grow.

In short, some companies can’t handle the SEC requirements just yet, but still want to see value grow on the market. They appeal to investors who see day trading as gambling, so to speak.

Penny Stock Trading FAQ's

Are penny stocks hard to trade?

Technically all you have to do is go into your app and sell the stocks, or talk to your broker. Selling it isn’t difficult, but knowing when to sell is difficult.

Penny stocks have almost no history, because if a penny stock does well enough, it’s no longer a penny stock. That mixed with thousands upon thousands of companies that just die out make it difficult to gauge the market.

You can liquidate penny stocks fairly quickly, it’s just hard to know when you should.

Can I buy and sell penny stocks on the same day?

You can, but be warned: if you do this on the NYSE, you can be flagged as a pattern day trader, which could restrict your access to investing in stocks. 

Pattern day traders are identified as someone who buys and sells stocks on the same day. This doesn’t have to be flagged if the amount that you buy and sell each day is under a certain percentage of your margin.

You want to avoid getting flagged as a PTD because it could restrict access in some instances up to 90 days.

Can you get rich from penny stocks?

It’s happened, but you shouldn’t bank on it under any circumstances. True penny stocks aren’t traded on the NYSE, and instead go through different markets.

This is great for access, but it operates under heavy risk. These small startup companies just want to be listed so that they can have value from the stock market, but their companies could simply flop overnight.

There’s so much more risk involved in an already risky investment practice (going with a single company stock instead of an index fund, in this case).

Penny stocks are all about buying in bulk and having quantity over quality. Hopefully, a penny stock will rise up from $0.01 to $0.10, and hopefully you will have been holding onto 10K+ shares when that happens, but it’s not guaranteed.

The rule of thumb is that you should never invest more than you are comfortable losing.

Should You Trade Penny Stocks?

If you have $100 or $1,000 that you wouldn’t miss if it were gone, then go for it. Penny stock trading is popular because of the prospect of flipping one penny into a dollar on a grand scale, but finding a golden penny stock is difficult. It’s akin to playing scratch tickets.

We all know there’s a $10,000,000 prize somewhere, but none of us can know where it is. Yet, some scratch away and ride the tide of losses and gains (figuratively speaking, of course).

If you can completely cut away all your emotional ties to the money you spend on penny stocks, you should invest in them sparingly.

Day trading can be a full-time career for a lot of people, but those folks usually spend their time on stocks that are $5.00 and under on the NYSE instead of penny stocks.

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About the author 

Donny Gamble

I’m Donny. I’m a world traveler, investor, entrepreneur, and online marketing aficionado who has a big appetite to compete and disrupt big markets. I thrive on being able to create things that impact change, difficult challenges, and being able to add value in negative situations.

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