The idea of trading penny stocks is a tantalizing one because the potential for a strong return on investment is always there. The concept is one of buying a stock for a penny and doubling the investment if it goes up by another penny. However, penny stocks are not the easiest kind of stock to buy and trade due to regulations and lack of visibility. There are ways to trade these stocks in a profitable manner, but you need to do your due diligence first, and that means researching the art of trading a penny stock.
The Basics of Penny Stocks
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Before you can make money with penny stocks, you need to understand what they consist of. The Securities Exchange Commission (SEC) changed their classification from stocks that traded for less than a dollar a share to stocks that trade for less than five dollars per share. They typically do not trade on the major stock exchanges and are more frequently found on an over the counter (OTC) exchange or are listed on something known as the pink sheets.
Penny stocks are also considered to be illiquid due to their low profile. You can buy the stock and realize an increase in market price, but can you sell that stock to someone else? If you can’t benefit from the increase in stock value, you run the risk of losing your entire investment because it’s stuck in a stock you can’t sell.
Only Invest What You’re Prepared to Lose
Penny stocks are one of the riskiest forms of stock trading you can engage in. They have the lowest profile of any kind of stock because the companies behind them don’t qualify for entry on the bigger markets. Their low profile puts them at risk of being used in pump and dump scams and manipulation by unscrupulous traders. From your point of view, you’re an investor looking to score a win on a lucky trade, but you can lose money because the stock wasn’t being used for honest trades.
Figure out how much you feel you can lose without it affecting your net worth and stick to that amount. If the stock explodes onto the scene and gains interest that leads to increased liquidity, you can cash out and not look back. But if the stock stagnates and doesn’t go anywhere, you’re not out a large amount of money.
Understand the Regulations Surrounding Penny Stocks
The SEC requires a penny stock to meet certain standards and definitions to trade on a stock market. If the stock trades on the NASDAQ National Market or through the OTC market, it’s considered a penny stock. If a major stock sees its price per share drop below five dollars, it is not considered a penny stock due to its pedigree and trading history.
These are some of the things to consider when deciding to trade penny stocks. Always exercise caution, don’t go overboard in the hopes a stock will see a swing upwards, and research the company before you buy the stock. Keeping your eyes open when trading penny stocks helps you avoid getting into trouble.