What is Penny Stock Investing?

Wall St. Nerd

A.Kelm

Updated on

January 13, 2023

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Penny stock investing is often the first natural stop for new investors. Penny stocks, as the name indicates, are equities with a cheap share price, generally less than USD 1. Because of the incredibly cheap pricing, an investor may own thousands of shares for a relatively modest amount of money.

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With that kind of scale, a gain of a few cents per share may result in huge percentage gains. Investing in the correct sorts of low-priced penny stock investing is one of the most successful ways to build large and quick riches. Excellent firms, regardless of their size, will always be able to offer exceptional investment returns to their owners. Because the main stock exchanges, such as the NYSE and NASDAQ, have listing requirements that must be satisfied, including a minimum share price, penny stocks frequently trade-off of them. However, with greater potential comes greater danger. Many people have been harmed as a result of these dangers, and penny stocks have earned a poor reputation in some financial circles.

Microcaps, small caps, stocks under USD 5, and other terms are used to describe penny stocks. However, some of them may not be traded on a major stock market, and all of them need a more sophisticated approach than other equities. Many investors are attracted to penny stock investing because of the potential for profit. They are attracted by the prospect of investing in a small business in its infancy and witnessing their money grow with it. After all, many penny stock businesses have gone on to become household names, making their early investors quite wealthy in the process. Penny stocks, like other forms of stocks, can be used as an investment instrument. However, a potential investor should use caution while making such investments. Due to their extreme volatility and little liquidity, the stocks are inherently speculative.

Definition

There is no widely recognized definition of a penny stock. Instead, financial professionals classify these low-cost stocks in a number of ways, depending on who is doing the categorizing and why. What one trader considers a penny stock may not be considered a penny stock by another. Penny stocks are those that trade at a cheap price, have a little market capitalization, are generally illiquid, and are listed on a smaller exchange. The price of a penny stock in the Indian stock market might be less than Rs 10 (in USD 0.14). Because of their lack of liquidity, a small number of owners, huge bid-ask spreads, and restricted disclosure of information; these stocks are regarded as very hazardous.

The phrase "penny stock" is used by the Securities and Exchange Commission (SEC) to describe security or a financial instrument that reflects a certain financial value, issued by tiny public businesses that trade for less than USD 5 per share. Penny stocks are priced over the counter rather than traded on a trading floor.

History

The Securities Exchange Act, established by the United States government in 1934, helped to bring order to the world of penny stock investing. The SEC classified penny stocks as any equity securities trading for less than USD 5 and not listed on any national stock exchange as a result of this statute. Bre-X Minerals was one of the most well-known cases of stock manipulation. Before its geologist faked a record gold find, the Canadian mining company's shares were worth a cent, propelling Bre-market X's valuation to $6 billion. The stock fell after he vanished and was subsequently discovered dead, and it finally sank to nothing. Pier 1 Imports was formerly the king of the home furnishings industry. This erstwhile behemoth now trades on the OTC Pink Sheets. To say the least, it has a dubious past on the New York Stock Exchange. The firm reached an all-time high in 2003, but shares fell when the financial crisis struck a few years later. By March 2009, it had dropped to 11 cents per share, only to increase again. By mid-2013, the stock had risen to USD 23.50. Smart investors might have made a 21,263 percent profit in only four years. (Source: US News)

Many firms in the United States have risen because of penny stock investing. In the following paragraphs, we will go through some of the key instances where penny stock investment resulted in a significant increase in a company's stock market. Many people are shocked to learn how many successful firms have been classified as penny stocks at one time or another. Ford Motor Company, Monster Beverage Corporation, Sirius satellite radio, American Airlines, Nokia, Lucent Alcatel, and many more well-known companies have all been penny stocks. In other words, these low-cost stocks are not always the shady businesses you have been made to assume!

Ford Motor Company is one of the major automobile manufacturers in the United States. Despite being one of the world's most well-known and well-known brands, the firm has had its share of difficulties. Ford's stock hit an all-time low of USD 2 per share in December 2008, amid the most recent economic downturn. However, less than two years later, in September 2010, the firm recovered, trading at USD 15.94 per share, a 797 percent return. Monster Beverage Corporation, best known for its Monster energy drink, is the stuff of penny stock fantasies. This is one of the most profitable penny stock investing ever. Once in a blue moon, a tale like this company's path comes along. Shares fell as low as USD 2 per share in September 2005. Let's fast-forward ten years... In 2015, Monster reached an all-time high of USD 140 per share. That is a 7,000-fold rise.

Penny Stock Investing and Level of equities

Many individuals believe that day trading penny stocks and becoming a billionaire is the ultimate rags to riches narrative. You may invest modest sums of money and earn large returns by trading the cheapest stocks on the market. Trading penny stocks is one option to jumpstart your investments if you are trying to enter into a new market. Microcaps, small caps, stocks under USD 5, and other terms are used to describe penny stocks. However, some of them may not be traded on a major stock market, and all of them need a more sophisticated approach than other equities.

Over-the-counter stock trading is divided into four levels by the OTC Markets Group:

Tier 1 Penny Stocks

Stocks traded on major stock exchanges such as the NASDAQ and the New York Stock Exchange fall under this category. They are generally under USD 5 per share, although they can be a little more. Because they must submit financial information to the exchange, they are held to stricter standards than OTC penny stocks, making them less susceptible to manipulation.

Tier 2 Penny Stocks

These are your standard penny stocks, with prices ranging from one cent to 99 cents. They have significant knowledge of Tier 3 and 4 penny stocks and may be relied upon in general. These businesses will generally receive a letter (which will be made public) stating that they must satisfy the listing requirements in order for their stock to trade over USD 1.00 within a specific time frame. If they succeed, the stock will stay listed; if they fail, it will be delisted and transferred to the OTC market.

Tier 3 Penny Stocks

These Penny stocks are frequently referred to as "sub-par." When a stock trades for less than one penny per share, it is safe to assume that the company is not strong enough to warrant such a cheap price. These penny stocks are not traded on the major stock exchanges. The New York Stock Exchange and the NASDAQ do not trade these stocks.

Tier 4 Penny Stocks

The pricing of these triple zero equities ranges from 0.0001 to 0.0009 cents per share. As you can expect, these stocks have frequently been exploited as a means of manipulation. Each increment represents a 100 percent increase over the entrance price of 0.0001. Many of the "hot penny stock" alerts are for sub-penny or trip-zero stocks, and they largely benefit the original purchasers.

Today’s Penny Stock Investing Worth

In the United States, penny stock investing is described as security that fulfils a set of certain criteria. Price, market capitalization, and minimum shareholder equity are among the requirements. Although penny stock investing in the United States is currently largely regulated by the SEC and FINRA, the origins of this regulation may be traced back to state securities laws. Broker/dealers specializing in penny stocks, such as Blinder, Robinson & Company, were forced to close or significantly restricted as a result of these laws.

Market capitalization (abbreviated as "market cap") refers to a company's overall worth, which is calculated by multiplying the total number of shares available by the price per share. The market cap of a firm is four million dollars if it has two million shares with a value of two dollars apiece. Some investors consider businesses with market values of less than USD 10 million to be penny stocks, while others consider companies with market caps of USD 25 million, USD 100 million, or even more. The majority of investors do not utilize market capitalization to define penny stocks. Some investors, on the other hand, prefer to concentrate their assets on firms of a specific size because of the implied stability that comes with larger companies, and in this instance, the market capitalization method may be useful.

After debts have been paid, shareholder equity (SE), also known as shareholders' equity, is the corporation's owners' remaining claim on assets. Shareholder equity is equal to the entire assets minus the total liabilities. A company's investors' worth might be good or negative. If the outcome is positive, the firm's assets are adequate to cover its liabilities. The company's liabilities exceed its assets if the value is negative. If this continues for a long period, it is referred to as balance sheet insolvency.

Types of Penny Stock Investing Orders

To comprehend the many types of trading orders and how to utilize them, you must first grasp how stocks are purchased and sold. When buying or selling shares of any sort of stock, you have two options: purchase or sell orders and sell orders.

  • Limit Orders
  • Market Orders

You specify the price you are ready to pay for the shares you wish to acquire when you submit a limit order. You can, for example, place a limit order for 200 shares of a company at a price of 65 cents per share. You will receive as many shares as are available at 65; if shares are available at a lower price, you will receive them at the lower price. Your trade order will not be executed if the shares have an asking price of 66 or above. That is until one of the vendors agrees to decrease his asking price to your limit price of 65. You agree to pay the best available price for a stock when you make a market order.

When you put a market order on a penny stock with an asking price of 65, for example, you agree to pay 65 for that stock. The disadvantage of using a market order is that you have no influence over the price at which the shares are traded. The advantage of market orders is that you will receive all of the shares you attempt to purchase. A market order merely expresses your willingness to accept the best available price. You may purchase or sell as many shares as you desire since there is always the best available price.

How to Trade Penny Stocks at the Right Time

It is more essential to know when to unload your penny stock shares than it is to know which penny stocks to acquire in the first place, whether you are Up or Down on your position. You could be selling shares to cash in on profitable penny stock investing or to offload a losing investment at a loss. While most people do not notice the difference in approach, these are two quite different circumstances with various factors to consider. Consider the following grounds for profit taking:

  • If the price of your penny stock is considerably higher than when you bought it, you may want to sell it to lock in the profits. You eliminate the danger of the penny stock falling in value by selling.
  • If your research indicates that disaster is on the horizon, you would be better off taking profits now than waiting for it to happen.
  • The penny stock may be set to tumble if it trades significantly higher but then sees a significant reduction in trading volume. When the excitement fades, the stock price frequently fails to hold its stratospheric new high.
  • Whether your trigger price is established in your brain or linked to an automated selling through your broker, you must sell your stock as soon as it reaches the specified price to limit your losses.
  • When your technical analysis predicts a price drop, selling shares may help you avoid more losses.
  • If you expected a specific event to raise shares but it did not, you should examine whether there is anything else on the horizon that may assist you to recover your losing position. If that is not the case, selling and moving on may be the best option.

Risks and Rewards in Penny Stock Investing

Penny stocks are thought to be extremely risky. For a price gain, these equities are dependent on market circumstances. Every company has its own set of risks, but penny stocks have additional factors to consider before investing in them. Due to the fact that penny stocks are issued by startups and firms with lower market capitalization, information about them is always restricted and unreliable. Penny stocks trade in the lower tiers of major stock exchanges or on lesser-known exchanges. Penny stocks are frequently used in frauds. This practice, known as "pump and dump," is used by many organizations and individuals involved in money laundering. They buy a large number of these stocks and inflate their value in order to attract regular investors. Chop stocks are another typical issue. In this case, a lesser-known broker will buy equities at a significant discount to the prevailing market pricing. It is difficult to identify a fair value for these stocks because they are rarely traded. Companies that are trying to stay afloat usually issue penny stocks. There is a possibility that these businesses may fail in the long run.

Penny stocks, despite their extreme volatility, provide excellent returns. They have the potential to provide substantial growth in a short period of time, and as a result, they have become one of the most popular investment options. With a modest amount of money invested, you can make a lot of money. They begin tiny, as their name implies. As a result, they have the potential to make it big. There are many reputable firms that deal in pennies. They may have proven leaders and teams, strong financial positions and favourable ratios, increasing market share, and innovative goods or services poised to disrupt an industry. If a person only has USD 500 to invest, they may only be able to buy three or four shares of a larger firm, but the same amount of money might buy thousands of shares of penny stocks. Although not all penny stocks see rapid price movement, those that do tend to do so in days rather than years. Most penny-stock firms are little fry with great aspirations, operating in the financial world's backwaters. However, if the investing public discovers them, the stock price may skyrocket in a matter of weeks or even days.

Conclusion

If you believe you have the ability to day trade penny stocks, you should educate yourself on how to do so, as well as money management strategies, to prevent losing all of your hard-earned money. This will familiarize you with how fast-moving stocks move as well as provide experience with hotkeys, which are essential for trading penny stocks or other momentum-based strategies. Of course, just because you locate a fantastic firm does not mean you will be successful. You need to know when and at what price to buy stocks, and technical analysis, but also to know more about the business may help you with that. The typical trading patterns we have uncovered and discussed in this blog article will neatly fill out your Leeds Analysis efforts by revealing buying and selling opportunities that the vast majority of investors will overlook.

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Hi, I'm Alexander Kelm.

Serial entrepreneur, value investor and angel investor. Founder of Wall St. Nerd. Join me here on wallstnerd.com to learn how to read financial statements, find healthy companies, and invest your money wisely.


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