Penny Stock: Investing Learn from Real Cases and Avoid Common Mistakes
If you enter an investment forum, you can be assured to hear two very different stories about penny stocks. Some traders will adamantly tell you how they turned $500 into $5,000 in a matter of weeks. Others will share how they have lost everything "trying to chase a dream that never materialized." So what are penny stocks, and what is with the extreme reaction.
Penny stocks are precisely what they reference: shares that are low priced, typically trading under $5 in the U.S. or under €1 in Europe. This does not mean you will see companies that you are familiar with such as Apple or Microsoft. Penny stocks come from smaller, often new companies that are traded on less regulated markets, such as the OTC (Over-the-Counter) markets in the U.S., Canada's TSX Venture Exchange, or Europe's AIM (Alternative Investment Market).
Key Characteristics That Define Penny Stocks
The most distinguishing aspect is quite clear: a low price per share. However, by just looking at the price, you are not understanding the full picture. If a stock has a price of $3, it is not a penny stock simply because it has a low price. For example, if that stock is traded on NASDAQ and has great fundamentals, it is clear that context matters. Typically, true penny stocks have both a low price as well as a low market capitalization (often below $300 million) and are traded on relatively unregulated exchanges.
The vast majority of penny stocks are traded on the OTC Markets in the U.S., which are tiered (OTC Pink, Least regulated; OTCQB, vetted but looser; OTCQX, highest OTC standards). Occasionally, some penny stocks trade on the larger exchanges (NASDAQ or New York Stock Exchange) if they meet the minimum listing requirements. Generally, those share companies are higher quality.
Advantages and Risks: A Double-Edged Sword
Penny stocks represent a contradiction. They offer opportunities that do not exist in large, established companies, however, the risks associated with penny stocks can quickly wipe out accounts. Let’s break both sides down candidly.
Here is a real life example: A small biotech company just announced positive results from their Phase 2 trial. After the announcement the stock opened at $0.85 and jumped all the way to $2.40 within three trading days, a return of 182%. Traders who had done their due diligence and positioned themselves before the announcement generated life changing returns on little capital.
How to Actually Invest in Penny Stocks (Without Losing Everything)
A real-world example: An institutional trader discovered a small company on an OTC-QB developing battery technology. The management team had obtained PhDs from MIT and patents were completed as well. They had filed quarterly financials consistently showing upward momentum. More importantly, the company had signed a development agreement with a large automobile manufacturer. The trader positioned in the stock at $0.65 and reached $2.10 after six months following a successful product demonstration.
To begin, keep it simple. Open a simulated trading account (most brokers provide this service free). Pick one or two penny stocks you like. Maybe it's a company in an industry you know something about, or a product you find interesting. Track it for 30-90 days without putting in real money. Watch news catalysts come into play, see what patterns of volume happen, and learn the ways each stock trades.
FAQ: Your Burning Penny Stock Questions Answered
Penny stocks tend to be best for investors who can tolerate volatility and can afford a complete loss of their investment. In other words, if losing $500 or $1,000 would hang around your neck as a financial burden, taking a chance on a penny stock is probably not a good fit for you as an investor. Penny stocks usually perform better for people having established emergency funds, retirement accounts set up, and at the ready, risk capital that has been earmarked for speculative investing. Personality also matters! If a 20% swing in a days trading causes you to panic - stick with an index fund. Penny stocks reward patience and decisive action - which is an uncommon combination of things most people do not have, even if they think they do.
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