Penny Stocks Explained – How to Trade Them
There’s nothing too special or technical about trading penny stocks. They’re just like normal stocks, but they happen to be priced much lower. In fact, trading them has the same steps as trading any other stock.
- Find a good and trustworthy broker
- Outline a budget for trading
- Don’t put all your eggs in one basket (diversify)
- Set up stop-losses
No matter what you do, the success of your penny stocks trading strategy completely relies on the broker you choose. The first is that the broker actually has the company listed you’re trying to invest in. And second, is that the company is well regulated and licensed by your local government agency. The license ensures that you and your funds are protected from any malpractice.
Once you’ve chosen a broker, you need to outline your budget. Why? Because stock trading, be it with penny stocks or regular stocks, is extremely risky. Just as much as there is an opportunity to get rich, there’s a risk of losing everything you’ve invested. Therefore, outlining the amount of money you’re pretty much ready to lose, is absolutely essential to keep your financial security untouched.
When buying penny stocks, also pay attention to how many companies you invest in. If you put all of your money in one company, and it suddenly encounters an issue, all of your accounts will be in danger. By diversifying your funds across multiple companies, you’re keeping yourself much safer.
Finally, to help cope with the inevitable, it’s recommended you set up stop-loss orders. These orders will immediately liquidate your assets if it drops in price too much. This helps prevent going to sleep with $1000 and waking up with $20.
Trading Penny Stocks - Is it Safe?
It’s a yes or no answer in this case. According to people who actually trade penny stocks, it’s completely safe and could lead to some serious yields. But those who are just watching from the sidelines continuously argue that it’s the worst decision you could make. And their arguments do have some merit.
There is a very good reason why a stock would trade under 5 USD per share. In fact, there are two reasons: A) The company is doing really really badly or B) The company is brand new and could collapse at any moment.
Let’s discuss variant A. In that case, if the company is doing quite poorly, there is no point in investing with them. The main idea behind investing is to gain something extra, right? Almost nobody invests with the idea that they’re doing something for the greater good. No, it’s purely based on monetary gains. So, if a company has shown in the past that they’re doing incredibly poorly, why would you want to risk your investment in them? This is the first risk worth considering before buying penny stocks.
The second option is much more promising than the first. There are honestly only 2 ways that a brand new company goes. It either disappears or gets swallowed by a competitor, or they start dominating their sector. However, the vast majority of new companies are simply bought by larger corporations, therefore continuous gains are unlikely from them.
By no means is trading penny stocks safe. Actually, there is yet another reason why it’s so dangerous - pumps and dumps. A pump and dump is when a company registers its stock for very little, maybe even like 10 cents per share. People flock to it, investing thousands of dollars buying as much stock as possible expecting the price to grow. Once it grows, the biggest shareholder (the company itself) simply sells all of their stocks taking the money and absolutely destroying the price.
This usually happens when the company lies on how much they made in revenue, artificially pumping the stock price, then selling most of their stocks either expecting it to completely drop or just waiting it out until the truth gets discovered.
What Are the Best Penny Stocks to Trade?
There is no clear “best penny stock” as in the name of the company. This is because markets change, so any company we may recommend now, may have lost its status within a week or so. However, there are ways of identifying a good penny stock at any time, so let’s explain that more clearly. We’ve managed to boil it down to around 3 key indicators.
- The company is contracted by the government
- Already substantial growth was seen within a year
- Current management’s history
If the company is contracted by the government, you know there’s a guarantee that they have lots and lots of income. Especially if they’re contracted by a government with more left-leaning policies. It means that they’re keener on government spending, thus the revenue of this company is not only guaranteed but quite substantial. Furthermore, governments tend to make contracts lasting many many years, so that revenue is actually sustainable.
When you’re trading penny stocks, or pretty much any other stock, it’s essential you check past performance. If there has been substantial growth noticed for the company in the past, and a replication of that growth is still within reason, then it might be the go-to stock. For example, if the price grew from $1 per share to $3 per share, that’s already a sign worthy enough to take seriously.
The history of the management team is also crucial. If there are any bad apples in the team, you can bet that something’s going to go wrong with the company anytime in the future. It’s best to be safe even with the people.