Beginner's Guide to Trading Penny Stocks

You Can Be Successful With Trading Penny Stocks

A woman smiling while sitting at a desk in front of an open laptop

Luis Alvarez / Getty Images

Penny stocks and low-priced shares are not right for everyone, despite the fact that they have a lot of great attributes. They truly can turn a small investment into a large sum of money pretty quickly, but they can just as quickly wipe those dollars out.

For many people, the potential for big rewards does not outweigh the risks. Be honest with yourself, and do not feel bad about walking away from the entire concept. In general, that is often the best choice, because most situations involving penny stocks result in many investors taking losses.

The good news is that it is easy to avoid the catastrophic losses that some investors make in trading penny stocks. The reason most investors are wasting their investment dollars is they are buying the wrong stocks, at the wrong prices, and usually for the wrong reasons, leading them to hold on to such stocks for far too long.

For example, the vast majority of investors who buy penny stocks that trade on the over-the-counter (OTC) markets will likely lose money. On the other hand, investors who buy well-known companies on regulated, major U.S. stock exchanges will more likely improve their odds of success. These are mainly serious companies, with proven business models.

Penny stocks, those with a price of less than five dollars per share, are likely to be companies that have fallen on hard times. Investors are signaling, through the price of the shares, that they have doubts the company will survive. If they did not have such doubts, the price of the stock would be higher. But if these companies have stocks listed on major U.S. exchanges, it suggests that these firms have passed some level of vetting and have produced sufficient financial disclosures to be allowed to list on such exchanges. This status signals that they have a healthier standing, some access to resources, and market knowledge, and that they have a chance to turn their business prospects around. Successful penny stock investors know that what they need to look for are signs of a business turnaround.

Risk Money and Honest Guides

You should only invest in penny stocks with risk money or those funds you can afford to lose. You also should only dip your feet into the waters of low-priced shares once you have gained significant knowledge and have a strong stomach for the potential volatility, which can sometimes be found with investments trading at the lowest prices.

Follow someone who knows the industry very well. An expert can help you avoid mistakes, and you can learn from their experiences, whether talking about penny stocks, home renovation, cooking, yoga, or otherwise. The caliber of your results will be directly proportional to the caliber of your guide.

Heavy Metal Lottery Tickets

People want to turn a few hundred dollars into total financial happiness and freedom, so they let their guard down and believe the promises. This explains the success of the "robot that picks stocks" scam, the popularity of the Iraqi Dinar, binary options, marijuana penny stocks, and every other "close your eyes and hope" stampede, from the Dutch Tulip Bulb mania to the California Gold Rush.

If you want more recent and relevant examples, just consider the volatility of Bitcoin or the dot com bubble. Whatever happened to Darkcoin, Peercoin, Gridcoin (which was founded by Rob Halford, heavy metal singer of Judas Priest), Namecoin, and Primecoin? Don't fall for the lottery ticket promises. Investing well in penny stocks involves some work, some knowledge, and some guts.

Start by Paper Trading

You can avoid big mistakes by learning how to trade with the risk-free, no-money-required method of buying and selling low-priced shares, known as "paper trading." All you need are a pen and a piece of paper to keep track of imaginary trades in real stocks, using a portfolio of imaginary money. 

Paper trading will probably be the best thing you will ever do in terms of penny stocks. By tracking imaginary profits and losses, you can make a more knowledgeable jump into real money. That will also help you learn all the relevant penny stock lingo, learn from your mistakes, and appreciate all the things to look for when you try to find the next penny stock winners.

After you have paper traded for a couple of months, you will be much better in every respect when it comes to buying and selling speculative shares.

Decide Which Types of Companies You Will Focus On

Most investors make the mistake of investing their money in whatever is the latest "hot industry." You know the one—it is talked about in the news, your cab driver mentions it, or your grandma calls you up to suggest you buy some. The problem is that by the time you hear about which industry is hot, it typically means that it is already on everyone else's radar. The trade is already crowded, matured, and heavily overpriced.

In other words, the next move for the latest hot industry is almost always down. When it comes to penny stocks, the change from current fad to former fad usually results in the shares of all of the penny stocks in that hot industry collapsing significantly.

The old expression goes, "Buy what you know." If you are a medical scientist, for example, you will have an advantage when trading biotech stocks. If you are an internet programmer, your advantage will come when you're looking at various technology companies. Or just buy what makes the most sense to you based on your readings and environment observation.

Your Passion

Not sure which types of businesses allow you the greatest advantage? Just take a look at what industry publications you have a subscription to, or what your passion involves. Mountain biking? Deep sea diving? Gold mining? Fashion?

Typically, people overlook their own industry and instead focus on what they think will make the largest difference for them. In so doing, they give up a major, pre-established advantage that they didn't even know already have. 

Our Human Nature

This is just human nature, especially since the last thing you want to do when you're done working for the day, is to focus on other things related to that exact same work. Not always, but often, chefs don't cook their dinner, painters don't paint their den, internet entrepreneurs don't surf the web (not too much, anyway).

You may be rewarded by reversing this psychology. Focus on those industries and corporations which you understand the best. When it comes to trading penny stocks, you want to bring every advantage to bear.

How Will You Generate Prospective Investments?

You need to find a source that is reliable and that you trust, and use that as a jumping off point to finding potential penny stock investments. In fact, you should probably have many sources.

Never trust any source 100%. Instead, use them simply to provide suggestions of prospective companies to watch. Then conduct your own analysis, make your own trades, and take full responsibility for the results.

You can find many stocks yourself by using a stock screener such as (Financial Visibility). This is an example of a great online tool for uncovering potential investments, which you will better understand how to use the more you try it out, the more you paper trade, and the more you learn about investing.

There are also great stock screeners online for free through sites such as Google, and most major financial portals. If you want stocks trading at $3 or less in the precious metals industry, you can set the screener to return only those results. This can then act as a great shortlist, through which you can find the penny stocks you want to trade. Many online brokerage platforms also enable users to screen stocks by industry and by price from low to high. Through this filtering and sorting, you can find the stocks in the price range you seek and you conduct more thorough research.

Frequently Asked Questions (FAQs)

What is the best stock trading site for penny stocks?

Online brokerages have a lot in common, so try out a few before deciding which one you'll stick with. Try to find a brokerage that charges as few fees as possible. Since penny stock trading is often short-term, you don't want commission fees to eat into each of your trades.

How much money do you need to start day trading penny stocks?

Penny stocks are subject to all the same trading rules as regular stocks. That means, to regularly day trade, you need at least $25,000 in your account. Otherwise, you're limited to three day trades per week.

Was this page helpful?
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. SEC. "Penny Stock Rules."

  2. Missouri Secretary of State. "Penny Stocks."

Related Articles