Is It Illegal To Buy Penny Stocks
No. It’s perfectly legal to trade penny stocks â or any listed security â with a regulated broker. However, it is illegal to do so with any non-public data , and penny stocks are more susceptible to insider trading and market manipulation than larger-cap companies.
As an example of the risks involved, penny stocks are often targeted for so-called pump and dump schemes. Promoters of such schemes will lure in investors with the goal of “pumping” up the share price, before dumping their own shares at the expense of the investors, often causing substantial losses.
Buying or selling stocks using insider information is a serious federal crime that carries a maximum sentence of 20 years and fines ranging from $5 million for individuals to up to $25 million for corporate entities.
The Lowdown On Penny Stocks
Successful companies aren’t born, they’re made. Companies usually have to work their way from humble beginnings through the ranks just like everyone else. Unfortunately, some investors believe that finding the next big thing means scouring through penny stocks in the hope of getting a piece of the next Amazon or Meta , formerly Facebook. In most cases, this strategy will prove to be unsuccessful. Here’s why pinning your hopes on penny stocks could leave you penniless.
How Do Penny Stocks Work
Penny stocks trade like any other stock except they tend to be riskier. Lower trading volumes mean that stocks exchange hands less frequently, which makes them less liquid.
The low liquidity of penny stocks makes it difficult to find a ready buyer, and you may have to sell your penny stocks for undesirably low prices. The value of penny stocks also tends to swing wildly, making them tricky to trade.
Since penny stocks have a lower share price and smaller market capitalization, penny stocks can be inherently risky. Not only that but penny stocks are often associated with non-credible companies.
Information can be scanty or unreliable because the companies are not covered by large institutional analysts. Therefore, they are not obligated to file with the SEC.
This dearth of information makes it tough to arrive at a good trading decision because of the lack of analytics. Unfortunately, penny stocks also tend to attract inexperienced investors who may not know how to analyze penny stocks.
Additionally, penny stocks can be subjected to pump-and-dump schemes. Pump-and-dump refers to an illegal scheme where price manipulators artificially raise the price of a stock based on misleading or exaggerated positive statements.
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How Much Should You Invest In Penny Stocks
Penny stocks are inherently riskier than bluechips or midcaps.
They present a huge growth potential. It is not unusual for a good penny stock to turn a multi bagger in a matter of months. But on the flipside, there is a high risk attached. It’s common to see penny stocks plunge 80-90% when things turn sour.
That is why penny stocks are not suitable to those having a low risk profile.
Even if you have a high risk profile, we believe not more than 5% of one’s stock portfolio be invested in penny stocks.
How Much Does It Cost To Trade Penny Stocks
The cost of trading penny stocks depends on the online broker you use. If you use a broker that offers flat-fee trades instead of per-share rates, trading penny stocks is not expensive. We also recommend avoiding brokers that charge a monthly platform fee, data fees, or monthly minimums, as those costs quickly add up.
Example 1 : TD Ameritrade charges a flat-rate $6.95 per OTC trade, while Fidelity charges $0 . Thus, your cost to buy OTC shares is just $6.95 and $0, respectively.
Example 2 : Interactive Brokers charges $.0035 per share with a max cost of 0.5% of the trade value. You buy 20,000 shares of penny stock XYZ at a price of $.13 per share . 20,000 shares x $.0035 per share is $70, while $2,600 x .5% is $13. Thus, your cost to buy the shares is $13 .
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Choosing The Right Penny Stock
Just because they may be much riskier than your average stock doesn’t mean you should completely avoid penny stocks. You can, after all, make some gains from these investments. So now that you know all the things you should avoid about certain penny stocks, let’s go through some of the points you should consider.
As with any other investment, do your research. No one knows your situation better than you. Doing your due diligence will help you in the long run. This means you should look up everything you know about the company, the risks it comes with, as well as whether it fits into your own investment strategy. Ask yourself if the underlying business makes sense to you as an investment. Don’t put any money into a company’s stock just because someone else recommends it or because it may be the flavor of the day.
Make sure you look over any information the company offers, including its financials. Are these quality statements? If the company reports its statements on time and the statements show that the company is financially stable, it may point to a sound investment. Be sure to do some research on the entity auditing the company as well.
How Not To Go Wrong With Penny Stocks
You need a very strong framework to pick the best penny stocks.
A framework that not only enables you to zero in on the right penny stock at the right price but also helps you avoid the big losers.
Here are a few pointers…
- Avoid all penny stocks with high debt. A debt to equity ratio greater than 0.5 is a strict no.
- Avoid all loss making penny stocks. Check out Equitymaster’s stock screener for high debt companies.
- Avoid all penny stocks with low promoter holding and penny stocks with promoter pledging.
- Avoid all penny stocks that are not generating cash flow from operations.
- Avoid all penny stocks where the business is at high risk due to some external factor like a change in government regulation.
- Avoid all penny stocks that are not available cheap. Insist on buying at least 20% below book value.
Feel free to check out Equitymaster’s Stock Screener to find the best penny stocks. The screener allows you to screen stocks based on your own criteria.
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Pros Of Investing In Penny Stocks
Hereâs a recap of some potential advantages of investing in a penny stock:
- When taking on higher risk with penny stocks, you might get a greater gain. After all, as an investor, youâd only be willing to accept a heightened level of risk if you had hopes of achieving a similarly greater level of share growth.
- Penny stocks tend to be investments in smaller companies. Size isnât everything, but these firms are usually younger and more nimble, which means they could experience more explosive growth and at a faster rate than older companies would.
- Penny shares are cheaper than some of the larger cap, more popular shares. So they might be more accessible to investors who find the share prices of other investments are higher than what theyâd like to spend.
How To Spot A Possible Winner
Most companies that trade with share prices under a dollar have relatively small market capitalizations, but as shown above, this doesnt always have to be the case. When it comes to investing, it is important to consider the strength of the companys fundamentals.
Does the management team rely on issuing new shares to raise capital? Is the company profitable or will it be able to turn a profit based on its current business structure? Can the company compete in its sector? For those willing to do their homework, there are definitely gems that can be found that meet these criteria.
As you can see from the chart of GGP, Inc. , the companys share price got battered down into the penny stock range during the financial crisis of 2008. For those who dont follow the company, GGP owned, managed, leased, and redeveloped real estate such as regional malls, until it was acquired by Brookfield Property Partners in 2018. Investors who kept an eye on the share structure, underlying fundamentals, and competition could have identified GGP as a prime candidate and profited from a tremendous rise in the years that followed.
Another key factor to consider is that certain sectors are more common for finding stocks that trade under a dollar. For example, the metals and mining sector is well-known for the number of companies that trade in pennies.
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Better Cheap Investments Than Penny Stocks
Fortunately, there are better alternatives to penny stock investing. Thanks to the rise of fractional share trading, which enables purchases of less than one share, you can often invest in stocks for which the share price is extremely high. For instance, a single share in a company like Alphabet costs thousands of dollars, but you can buy any fraction of a share and still gain portfolio exposure to the stock’s future performance.
Moreover, high-quality companies can have low share prices. All of these companies’ share prices were less than $10 in early 2022:
These are just a few of the stocks that you can buy without spending a lot for each share. Investors who are willing to assume high risk in order to potentially achieve high returns have plenty of stocks from which to choose that offer better risk-reward dynamics than penny stocks.
How To Find And Invest In Penny Stocks
Investors with high-risk tolerances often turn to penny stocks, which are defined as companies trading at a share price below $5. But as their name suggests, such stocks may trade for less than $1, allowing investors to hold thousands of shares for relatively small amounts of capital. And when the price spikes to multi-dollar levels, investors stand to gain handsomely.
But such stocks could just as easily fall to zero. Not surprisingly, penny stocks are generally considered to be highly speculative because of large bid-ask spreads, small , and lack of liquidity. This article details guidelines to help investors navigate the often thorny penny stock minefield.
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Next Steps To Consider
Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Investing in stock involves risks, including the loss of principal.
Investing involves risk, including risk of loss.
Past performance is no guarantee of future results.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
Penny Stock Vs Regular Stock
Penny stocks are shares issued by companies that trade for less than $5, which is very low considering other types of stocks are priced much higher. Aside from the price discrepancies, there are a couple of other fundamental distinctions.
An investor wondering how to invest in penny stocks will find that they are typically not listed on major stock exchanges like the New York Stock Exchange or the Nasdaq Stock Market. Most other types of stocks are listed publicly, but penny stocks can only be found as over-the-counter stocks.
Penny stocks are also traded less often than regular stocks, which makes them illiquid. This means buying and selling penny stocks is less efficient due to the wide gaps between the starting costs and the asking prices.
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How To Find The Best Penny Stocks To Buy
When it comes to finding the best penny stocks to buy, there are easier ways than just picking a random ticker trending on Twitter. First things first, the best refers to stocks that have the best opportunities to make a strong move.
Heres where a good penny stock screener will come into play. Youve got your pick. Some of the best penny stock brokers offer built-in screeners and options for you to design your own. Personally, I think TD Ameritrade has a few good options. You could also use things like Trade Ideas or FinViz to put a scan together to find stocks under $5 that meet certain criteria.
Beginners Guide To Trading Penny Stocks
Making money with penny stocks is a sweet science but one that takes practice. These cheap stocks are highly volatile and with that, very risky. But if you can make a living trading these stocks, what more could you ask for?
The appeal of quick returns is quite obvious. Who wouldnt want to invest a few hundred bucks to make a few thousand? But at the end of the day, 9 out of 10 traders will end up losing money and quit. Who do they blame? The companies, penny stocks in general, a mentor anyone but themselves get blamed. The reality is that the only person in full control of your trading is you.
So if you really want to make trading penny stocks a usable skill, education is the first thing you should think about before placing a single trade. The fact is, flipping penny stocks is harder than most will admit.
Not only does your trading strategy play a role, but youve also got to consider the psychology of trading. Theres no magic spell to making money with penny stocks. But there are things you can do to ensure that youre on the winning side more times than not.
In this article well discuss all of the questions you have about day trading penny stocks, how to invest, what certain terms mean and why penny stocks can make you money. Just remember that once youre done reading, your education doesnt stop there its just getting started! So without further ado, lets get into it.
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Should I Invest In Penny Stocks
The attraction people have to penny stocks can often be psychological. It might make sense that a $0.50 stock has more of a chance to double than a $1,000 stock.
However, penny stocks are traded at lower rates for a reason, whether its poor fundamentals or diminishing prospects. Stocks from small companies can be extremely volatile, often leading to substantial losses.
With so many investment options available, theres no reason to gamble on high-risk companies that issue penny stocks. A safer long-term investment would be ETFs. While you can find some penny stock ETFs, youre still taking on the volatility of riskier stocks when you invest in penny stocks.
MoneyLion offers a fully-managed stock and bond ETF portfolio, making it easy to invest because MoneyLion does all the heavy lifting for you. You also get to tailor your portfolio according to your personal preferences, all for a low monthly administrative fee of $1.
Is Investing In Penny Stocks Worth It
Workhorse Group Inc. is another clear example. When WKHS stock first hit our radar it was trading around $0.85. That penny stock is now worth over 17 times what it was back in May of last year. Solar energy hardware provider Enphase Energy Inc. has made early buyers of this penny stock a lot of money since January 2019. At the beginning of the year, ENPH stock was still trading below $5.
It had just experienced one of its strongest moves in 2018, which took shares from roughly $2.40 to around $4.80. From then on, ENPH stock managed to climb to highs of $118.94 in 2020. That means an investor with this on their list of penny stocks to buy at $2.40 couldve made 48.5 times their money. Even investing $100 into ENPH early, wouldve been worth nearly $5,000 by this year. When you consider how to invest in penny stocks with $100, ENPH is a prime example of a long-term approach to the right penny stocks to buy.
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L Is For Long Term Business Viability
This is perhaps the only component of the framework that’s more qualitative than quantitative. In other words, it is difficult to reduce this to a number. Besides, it is also future looking and doesn’t draw information from the facts of the past like other components do.
Here I am not looking for companies that are the fastest growers. I don’t think I have any special ability to do so. Instead, I am looking for companies whose business models are likely to be around at least few years from now.
If the company is from a dying industry and has been consistently reporting falling revenues, it is going to be a big red flag.
On the other hand, I won’t mind a company that’s growing slowly than the others or is exposed to the vagaries of the business cycle. As long as it has a sustainable business model and is here to stay, it will have my vote. This component of the framework is mainly to ensure that one doesn’t get involved with a value trap in a dying or a declining industry.
How Do Beginners Buy Penny Stocks
For beginners who want to buy penny stocks, the following checklist can help improve your experience buying and trading.
1. Choose a reputable broker: Pick a trustworthy firm to open an online brokerage account.
2. Analyze details: Research the penny stocks you are considering as much as possible, which is difficult given the lack of reporting required by OTC exchanges.
3. Stay safe: Avoid penny stocks that are susceptible to market manipulation such as those targeted by “pump and dump” schemes, or that you may have heard about on online forums and in chat groups.
4. Diversify properly: Make sure that you diversify your portfolio to avoid putting too much at risk in one or more penny stocks.
5. Have a strategy: Decide what price targets you have for the upside and downside , where you would exit the trade, or on a time-horizon for which you are willing to hold the position, regardless of the price action.
6. Take long-term views: Choose quality companies that have long-term potential for growth, and be willing to endure long stretches of time where such results may be delayed, including in the reflected penny stock price.
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