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Quick & Easy Guide to Trading Penny Stocks

Description: Penny stocks are stocks that typically trade for under $5 per share. They are usually characterized by high volatility. That means they are risky. Let’s explore further!

Introducing Penny Stocks Trading

Penny stocks were popularized in the mass-market with movies like the Wolf of Wall Street starring Leonardo DiCaprio, Jonah Hill Matthew McConaughey, and Margot Robbie. It was based upon the real-life experience of shamed Wall Street penny stocks trader, Jordan Belfort. What made the movie such a sensation was the electric energy generated off trading activity, and the indulgent benefits that Wall Street’s finest enjoyed from that. The hyped-up Hollywood version of penny stocks trading may be true for some, but it’s certainly not the standard for most.

Reality Check Tip: Penny stocks trading is inherently risky and the majority of traders will lose money. Only those who follow a regimented trading strategy, with ongoing learning will succeed.

Penny stocks do not cost 1 penny; on the contrary, these stocks can range widely in price from fractions of a penny up to $5 per share. The Securities and Exchange Commission (SEC) defines penny stocks precisely that way. If a stock trades on the New York Stock Exchange, the NASDAQ, the S&P 500, or the Dow Jones Industrial Average and it is priced at $5+, it is not considered to be a penny stock. Upon further inspection, it is clear that penny stocks are small cap stocks, since the number of shares X price per share is a small amount, compared to mid-cap stocks and large-cap stocks. For this reason, you’re more likely to find penny stocks on the Russell 3000, Russell 2000, and Russell 1000 index than you are on the S&P 500, NASDAQ, or DJIA

How Do You Trade Penny Stocks?

That’s the million-dollar question! Truth be told, there are differences in the way a trader approaches penny stocks trading, compared to trading blue-chip stocks. For one thing, penny stocks are largely unproven stocks, with nothing more than a strategic blueprint vis-a-vis the company’s mission. They are either in the start-up phase, or in the infancy stage of the company’s operations. They have a lot of upside potential, but they’re also characterized by tremendous risk.

Having said that, it is incumbent upon traders to employ due diligence, careful market analysis, and lots of reading before dabbling in the penny stocks arena. Timothy Sykes explains how to trade penny stocks in an article which covers every component of the penny stocks market in easy-to-understand language. It’s important to read up as much as possible before you drop anchor with a trading platform and broker. If things don’t work out for penny stocks companies, stocks can plummet overnight, and companies can close up shop immediately.

It won’t hurt to get tutored by penny stocks gurus, watch webinars, trading videos, and read up extensively on market dynamics for these volatile financial instruments. Many new traders and investors are drawn to penny stocks like moths to light. They are cheap, and if they boom, there is minimal capital outlay for tremendous upside potential. The trick to trading penny stocks is twofold: picking the right stocks at the right price, and being able to decisively cut your losses, and take profit. Too many traders stay in trades too long. If the market goes against them, they drag their feet in expectation of a reversal, or if the market is bullish, greed kicks in.

Warren Buffett the legendary investor said it best, ‘Be fearful when others are greedy, and greedy when others are fearful.’ But what exactly does that mean? In the case of penny stocks trading, you should not necessarily stay the course when everyone is holding on to stocks expecting the price to continue appreciating, and it also means that when everybody is selling off penny stocks, that may be the opportune time for you to buy any stocks – the proverbial buying on the dip. All of this posturing and pandering doesn’t really teach you how to trade penny stocks – that’s coming up next!

The Nitty-Gritty of Trading Penny Stocks

It is generally accepted that an investor believes in the company that he or she is investing in. An investment is a long-term value proposition where the current price is expected to appreciate over time. Otherwise, why invest? Trading is not investing. Many people have an incredibly difficult time understanding the differences between these two mindsets. When you trade stocks, you don’t have to have confidence in the company either way. What you do need is an opinion based on sound reasoning, educated assessments, and decisive action.

That means you need to have an idea of what is likely to happen to the stock price per unit time. Take emotion out of it. You don’t have to believe in the company, or be invested in the long-term well-being of the stock. Trading, particularly day trading is a short-term vocation. Your relationship with the stock is impersonal – there is no need to get attached to it as part of your financial portfolio. What you want is for the stock to either appreciate in price, or depreciate in price, and profit accordingly.

Let’s take the case of company ABC with a stock price of $1 per share. As a penny stocks trader, you may be encouraged by the technology used by this company, or the interest that has been shown in the company’s products and/or services. How would you know? The media. Research will provide you with valuable information such as financial reports, press releases, mentions in newspapers, magazines, and other online sources. Generally, positive news related to a penny stock will result in price appreciation. Negative news will result in price depreciation. By keeping your finger on the pulse, staying the course, and making calculated decisions, you can generate favorable returns from penny stocks.

Volatility is a key component of penny stocks trading. You will see prices whipsaw wildly at any given time. That’s why leading penny stocks traders strongly advise against using market orders because your trades will execute at the wrong prices and that could blow you out completely. Most penny stocks trade on Pink Sheets, and listing services such as OTCBB. Reputable traders tend to discourage the use of Pink Sheets since they are not registered with the SEC and they’re riskier propositions.

While some traders eschew volatility [since it’s difficult to stabilize your financial portfolio when prices are going all over the place], it’s absolutely necessary for you to generate a profit. There are those who will never touch penny stocks because the market is saturated with dishonest companies, but even so, careful planning can help you to safely navigate these waters and generate small, incremental profits over the long-term, which ultimately become substantial over time.

Updated October 11, 2020

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