Pennystocks, we've all heard of them. Penny stocks are like the wild west of stock trading. If they don't trade on the big stock exchanges, then they're subject to massive manipulation.
So how can you avoid that? Good news is that we've put together a full tutorial for you. Read it and learn how to protect yourself.
- The popularity of trading pennystocks has increased over the years. The internet has made information and their analysis more easily accessible to the masses. We wish to explain to our readers what are penny stocks and what makes them so popular.
1. What Exactly Are Penny Stocks?
The Securities and Exchange Commission (SEC), the U.S. market regulator, defines pennystocks as a security that is trading under $5/share. So not precisely pennies but still low priced stocks.
Most penny stock companies are new. Which means they lack much of a track record. And their market capitalization (market cap) is also small relative to “blue chips” (big companies that are well established and often pay a dividend).
They're cheap and can have a lot of volatility. Therefore, investors consider penny stocks speculative. They can either create significant gains(100% up) or losses(60% down) in a single day.
When you add margin trading into the mix, these gains and losses can be further amplified.
For this reason, knowing how to trade these stocks is so important. Check out our penny stocks list for a nightly watch list.
2. The Two General Kinds of PennyStocks (OTC vs. NYSE/NASDAQ Penny Stocks)
The riskiest of pennystocks are the Over The Counter (OTC) pennies; also known as “Pink Sheet” pennies. The wildest swings happen with these stocks.
And the least information is known about them because they're not required to follow the strict financial exchange rules the same way as their cousins. The pennies listed on the (New York Stock Exchange)NYSE and the Nasdaq exchanges. The three main rules being:
- Fully transparent financials
- The price stock must remain above $1.00 per share
- Not in a bankruptcy filing
Looking at these three rules, you can easily understand why it's not recommended to trade in OTC penny stocks. OTC pennies can be easily manipulated by traders.
They can hide their actual financial status. While also being much less regulated. And they usually have much lower liquidity, so your trades may be very slow to be filled. Volume is so important!
Even the NYSE and Nasdaq penny stocks can have some wild price swings. So don’t feel like you're missing out on the roller coaster at the amusement park.
Stocks in the Tech, Biotech, and Fintech sectors, priced between $1 and $10, can see overnight news that will cause 50% drops or 100% gains. With a total loss possible if a company declares bankruptcy.
3. Penny Stock Tiers
There are 4 tiers to pennystocks. Let's take a look at those below.
- Stocks in which we will focus, listed on a major exchange priced more than a dollar, usually under $5 per share but sometimes just over.
- Stocks trading between $0.01 and $0.99 and are often still listed on a major exchange but must meet the listing requirements within a specified period of time or be de-listed. Tier 2 stocks may be traded in fractions of a penny.
- Stocks priced below $0.01, do not meet minimum requirements, so they cannot be listed on a major exchange. Many online brokers will not even allow trading of Tier 3 or 4.
- Stocks trading at 0.0009 or less called “trip zero” or “hot penny” stocks. Susceptible to pump and dump schemes low volatility and manipulation.
PennyStock Trading for Beginners
- When you trade the cheapest and most volatile stocks on the market, you only need to invest a small amount to see a considerable return. However, the estimate of traders who are successful in trading is between 1% and 10%; with 90% losing money. Even the majority of fund managers can't beat the market.
With that warning said, the goal for pennystock trading is to identify any of the small group of stocks that each day are positioned to make a big move. There are usually three criteria used to identify either small-cap or penny stocks that have the potential to move:
- News catalyst
- Max float of 100m shares
- High Relative Volume (RVOL)
1. Finding the Gems
It's best to think of pennystock trading as either mining for gold or gems. You'll spend most of your time looking around. This means a little time digging and even less time finding the big ones.
Scanning the markets for stocks that match these criteria is needed. Depending on the service you are using to trade, they may already have such a scanner in place. Or you can create one yourself to look for specific criteria.
That’s where scanners come into play. Customized scanners to find stocks that only meet specific parameters gives you an edge because you're only trading stocks that have the potential to make a big run.
There are several sources that to obtain info. What you choose is of personal preference. Scanning for the high of day “MOMO” is worthwhile. MOMO is a stock trading tool that streams the new daily high and low breakouts in real-time.
This allows you to find stocks that are moving quickly with high volume, great for just after the market opening. MOMO is good if you don’t have any stocks you are following premarket.
Additionally, you can look at stocks that are the most active in the morning with a premarket mover scanner like the one I created below:
This shows stocks that have a gap up in the market. Gaps often identify that news has come out about the stock. This also meets the volume and price requirements I put in.
2. Using the Three Criteria
- News catalyst- The first step is to understanding which stocks might be moving and therefore search for news such as earnings announcements, governmental approvals, or partnership/sales/merger announcements.
- Max float of 100m- Float is the number of shares available for trade. The lower the float below 100m, and closer to 50m shares, the better; this way, there is significant volatility in the price, and it is this fluctuation which can be traded.
- High Relative volume- starting with the premarket, if a stock has high RVOL it is a good sign
When we have the three combined, we have a gapping premarket from the news. And both volatility tied to the low float and liquidity related to high volume so that trades can smoothly go through. A now perfect candidate for watching is identified.
Once a watchlist is created, it is now time to look at the market opening. Two things can be looked for:
- A further breakout over the premarket high(buy if continues to go up)
- Look for the Bull Flag pattern or Flat Top Breakout
3. The Bull Flag Pattern
Look for bull flag patterns on pennystocks. This is an easy to identify pattern of candlesticks, because it looks like a flagpole with the flag draping to the right. There are two parts to it:
- The “Run up”- buyers are creating the poll with prices higher with momentum.
- Consolidation- the flag happens when fewer and fewer buyers purchase shares with those thinking it's too extended, and sellers will take gains. When this bottoms out, with the first “New High” is when buyers are starting to come in again.
- Look for price to jump higher(buy now) with a profit length potentially equal to the flag poles size.
You're looking for a flagpole that has a clear, fast, and huge move up with big volume. Then a flag with light volume pullback that is orderly (to the 10-20 day moving average).
Not one with big price swings. You're looking for the jump in point to ride the increase with other buyers and out with the rise like the flagpole.
4. The Flat Top Breakout(AKA Ascending Triangle)
The second best pattern for pennystocks is the flat top break out. Also known as ascending triangles. Here will be a runup to a resistance point where the sellers will push the price back down a few different times.
But each time it'll be to a lesser degree (the green line). There will be a point that these take profit. Stop orders will be exhausted and it'll break above the flat top. That's the signal to buy.
With a buy, the risk of this pattern is a bit harder to project. The low of the candlestick that breaks out can be the stop order price; or a specified 15-25 cents can be the risk as well.
Is Pennystock Day Trading or Investing Viable?
- As we said before, 90% of day traders don’t make any money. And only 1-2% are genuinely successful. If you're just trading pennystocks, with their unpredictability and volatility, this's even less; especially for the novice. News of a takeover can cause a horrible company to jump up 100% or more. And of course, that is right after you short it.
Penny stock traders need to have a short term outlook. Then be one of the first traders to get in and to get out with a profit. Anyone that claims to be an expert penny stock trader isn't just trying to fool you, but is fooling themselves too.
I look at pennies as a bet at the Vegas tables. Never bet more than you can afford to lose cause you'll likely lose. If it comes in, treat yourself to a nice dinner with the proceeds. But don’t expect to make a living from it.
1. Ignore Tier 3 and Tier 4 Pennies (OTC/Pink Sheets)
These aren't required to adhere to the same reporting requirements of their Nasdaq and NYSE cousins. They have higher volatility and lower volume.
They're also susceptible to fraud such as the “pump and dump”. Where a holder of the stock will market the heck out of it stating “the next Microsoft/Apple/Tesla/bitcoin” on every email, blog, Twitter post, and Facebook group it can with hopes to lure unexpecting investors into the stock.
Then it sells its own shares for a profit; made from the unexpecting ignorance. If it's that good of an investment they won't have to market it
2. Ignore Pennystocks Without Volume
If pennystocks only have a few thousand shares trading each day, give it a pass. Because when you want to close your position, you wont have a buyer/seller.
If there's news and the RVOL is up 50 times then you have a winner. This happens nearly every day. So just keep an eye out for these.
3. Make a Plan and Stick to It
Like it was stated before, think of pennystocks trading as gold or gem mining. You're going to be more successful if you pick up a lot of small nuggets rather than just looking for one big one.
Once a penny stock ticks the watchlist criteria (news, float, and volume) look for the setups. Then other traders will be coming in too.
For money management, I would suggest selling half of the position once you have a profit. Then set the stop loss at your entry point so that the worst you can do is break even.
Raise these as the price goes up and fingers crossed; you've found that big gem or nugget. Set both your goal and your loss from the start.
Then reposition when you achieve it or get out. Either look for another, or wait till tomorrow. Don’t try to overthink it. Stick to your criteria and your plan.
4. Recommendation for Beginner Traders
I would recommend for the complete pennystocks beginner, you start with a trading simulator. This'll give you a chance to practice without risking any real money.
You can see what happens, try a bit, and even get a feeling for how it is to make a trade. You're only putting your fake money at risk.
Once you have a little experience, start with stocks that are between $5 and 10 dollars. The volatility and risk will be less. And you'll start to understand how a resistance zone works and what being a trader is all about.
As well as how to recognize the signs. As you gain more experience and confidence, you can dip your foot into the lower-priced stocks. See if you can keep up the results.
Pennystocks Closing Thoughts
Successful pennystocks trading requires a lot of prep work, the ability to trade with a plan with quick decisions rather than a gut instinct. As well as a strong constitution for the inevitable losses.
You will get better with experience. And remember the more you learn, the better you'll be at trading. We hope this has been a helpful guide and wish you the best of luck with your trading.