Trading and investing in penny stocks has begun to interest more and more investors over the years. The main appeal of these equities is the ability to make a lot of money with penny stocks without spending a lot of capital. Well-informed penny stock day traders can see those quick profits but those less informed may be in for a surprise.
Like most other things involving making money, it takes time and practice. Anyone can learn how to make money with penny stocks if they invest some time into learning, first. Trading penny stocks is a completely different ball game compared to mid or large-cap investing. Think of it like a stock on a 24-7 sugar rush; volatility is very prevalent.
What Are Penny Stocks And Where Can You Trade Them?
A penny stock is widely considered to be any small-cap or micro-cap stock. In addition, some people also feel that stocks are not penny stocks if they are trading on a major exchange. The definition of penny stocksare securities issued by companies that trade for less than $5.
Major exchanges include the NASDAQ or the NYSE. Typically, you will find the majority of penny stocks available on the Over the Counter (OTC) market. When discussing exchanges, it’s important to understand that each of these exchanges has its own standards that companies must meet. The NYSE exchange requires companies to maintain a minimum market cap and share price. Furthermore, companies must provide up-to-date and accurate financial statements to the public.
In comparison, the OTC market only requires companies to meet the minimum financial statement requirements. OTC markets also have Pink Sheets. The companies listed on Pink Sheets do not have to disclose nearly as much as anything trading on the NYSE or NASDAQ. This makes them extremely risky for investors due to the lack of information available to make an informed decision to buy penny stocks like these.
Find The Best Penny Stocks
One of the most difficult aspects of penny stocks is knowing which ones actually have profit potential. If they lack this, how is a trader supposed to get strong returns? When looking for penny stocks to buy, key factors include a strong company strategy, assets/cash, and the ability to generate revenue.
Some companies like to reveal future plans on how they are going to continue developing their businesses alongside financial reports. This allows investors to find companies truly looking to grow. Future acquisitions, product development, and improvements to current company practices are very good goals to have from a company perspective.
Assets and cash on hand are significant for companies. This ensures investors that a company will be able to sustain operations for future periods. Also, it allows a company to avoid liquidating important assets of their business structure.
If I told you that I had a really cool company but consistently had net losses, would you invest in it? Probably not. While bigger companies can post net losses and be somewhat fine, small-cap stocks cannot afford that. Investors want to see a company that can produce profits and build on revenue instead of losing it.
There are thousands of stocks that are traded across markets. It is physically impossible for any single trader to keep an eye on all of them. It’s even harder to sift through each one and see if you like them. However, there is a way to make your life easier when trying to find top penny stocks.
One of the best ways that traders find the best penny stocks is through the use of scanners. Penny stock scanners allow investors to zero in on aspects they find important in companies. They cut out all of the excess noise from other stocks and put what they want on a silver platter. Once you cut out those stocks that don’t meet your criteria, you can dig further into the companies that have been filtered for you.
Generally, scanners for penny stocks revolve around 3 significant criteria. This includes news, the float of a stock, and high relative volume. Almost every day, a penny stock goes flying bringing investors ridiculous gains. When this happens, you can see that they likely had some big news drop right before the massive move. This is the reason breaking news should be a factor for your scanners.
In regard to float, there are a few things to understand first. Float is the number of shares that are able to be traded in the public market. It is calculated by subtracting a company’s outstanding shares and restricted stock. A 50 million float or lower usually catches attention first. The lower a company’s float, more quickly the penny stock could move with increased trading activity. Similarly, with a low float, light selling pressure can also trigger a downward trend for penny stocks.
Relative volume is also important when deciding whether or not to buy penny stocks. It shows investors how current volume stacks up to past trading sessions. First of all, if a penny stock lacks volume, a trader might not be able to get out of their position. Second, a higher relative volume shows that there is likely a stronger interest in a specific stock. Third, high volume can give more liquidity to penny stocks, which can make it easier to enter and exit trades.
By using these filters and further personal preferences you can make a very strong penny stock watchlist. The list will help you track which stocks are the hottest that matched your criteria and constantly update every second. You can use pre-market hours to go through your watchlist and prepare a game plan for the upcoming trading session.
Using financial ratios is a very good way to improve your fundamental analysis when deciding which penny stocks to buy. Because you now understand how certain exchanges have standards regarding financial statements, these ratios are easy to find and use. The ratios are very good when comparing to companies in similar or competing sectors.
Valuation ratios can take a stock and measure its value at
its current price. This is particularly useful for penny stocks where some may
be very over or undervalued. A very good valuation ratio for penny stocks is the
price to cash flow ratio. You can find this by dividing the current share price
and the total cash flow from operations.
The second form of financial ratios is performance ratios. This type is probably one most investors are familiar with as it consists of profit margins and returns on assets. These ratios help investors evaluate whether or not a company is profitable or utilizing its assets efficiently. Like we stated earlier, no one wants a stock that is not making money.
Liquidity ratios are probably one of the most important
ratio types due to the nature of penny stocks. Because penny stocks are
uncertain, you could be looking at a company not able to grow or is dying. This
is where liquidity ratios can help you. A few examples of liquidity ratios include
cash ratio, current ratio, and quick ratio.
The final type of ratios to take look at is the leverage ratio. These show how likely and capable a company is able to cover its debts. For instance, let’s say a company borrows money to buy assets. The company needs to be able to cover the interest expense associated with borrowing that money every month. The type of leverage ratio that would show this is interest coverage ratios. The lower the interest coverage ratio, the worse-off a company is.
If you are looking at a penny stock traded on a public exchange you will have no problem calculating these ratios. However, some
companies on the OTC and Pink Sheets will not have this information because of
relaxed regulations. Remember, do not invest in these companies if you do not
feel confident in them or cannot gather enough information.
By this point, you have found penny stocks to trade that fit your requirements. Now it’s time to look a little deeper. This consists of digging into a company’s past financial statements, debts, management personnel, news releases, and past lawsuits. This is known as conducting fundamental analysis. It is the most common way traders decide whether a stock is worth putting their money into or not.
After you have conducted thorough fundamental analysis, some traders like to move to technical analysis. Technical analysis can further confirm your thoughts regarding a stock by dissecting its past price action. There are myriad ways traders utilize technical analysis, but it is best for determining potential entry and exit points.
One of the most used technical analysis tools is the relative strength index. It is one of the most reliable indicators when trading penny stocks. The relative strength index or RSI is a momentum oscillator measuring the change of price movements as well as speed. The RSI’s scale goes from 0 to 100.
How does the relative strength index work? Typically, if a penny stock has an RSI of 70 or higher it’s considered overbought/overvalued. This could potentially indicate that the stock is ready to reverse down. Alternatively, if a stock has an RSI of 30 or below it is considered oversold/undervalued. This might mean that the stock is ready to become bullish again and move up.
More professional traders like to make the range from 20-80 instead of 30-70 for the RSI. They feel like it weeds out a lot of fake breakouts when they trade.
Have you ever heard an investor say, “I am waiting for the stock to find its bottom”? This strategy revolves around penny stocks continuously dropping and then eventually finding that bottom or “lowest-low”. The stock needs to find its bottom and maintain it for a period of time, or trade sideways.
This could be an indicator that the penny stock is ready to come back up. Usually, that upward push will need a strong volume surge, which can be triggered by penny stock news.
This price action pattern is extremely similar to the bottoming-out pattern discussed before. With this pattern, a penny stock has been climbing continuously and then begins to trade sideways for a period of time. Two different situations could come from this scenario.
First, the stock could be simply consolidating and is ready to push even farther up. The second scenario would be that the stock is overvalued and is ready to come back down. It’s a safe strategy to get out once the stock starts trading sideways. This is because you can always get back into it if the stock continues upwards.
Earlier, I talked about a stock potentially consolidating and then continuing its rise. This occurs when some shareholders take profit. In addition, there are other investors who still have faith in the stock and continue to hold on to their positions or buy more.
This could become a bullish indicator if a penny stock trades sideways and with a higher average volume. Once all the sellers are gone, the stock is likely able to move upwards. This is usually due to more people buying the penny stock with minimal selling pressure occurring at the same time.
Everyone knows the saying, “buy low, sell high.” The same applies to penny stocks as well. The only difference is that these highs and lows come a lot more frequently. This increased frequency is good for investors who can time the moves correctly. Also, when buying and selling, focus on a stock’s volume as it can be an indicator of its strength.
Candlestick penny stock chart patterns are another tool that traders use. They can help investors plot the likelihood of future price action based on past price action. Typically, when a stock follows the same pattern multiple times, investors love to hedge their bets and trade the stock.
Support and resistance lines are some of the simplest technical analysis tools that traders use without even realizing it. A support line occurs when a stock finds “support” at a certain price and bounces off it to move upwards. This support line becomes stronger the more times the stock bounces off of it.
The opposite happens with resistance lines. If a stock in an uptrend gets stopped and starts moving downwards it is considered a point of resistance. Like support lines, if this continues to happen at the same price, it becomes a stronger resistance line. In the event stronger support or resistance lines are broken, it can be a sign of a much more volatile breakout or breakdown. So keep this in mind.
The hammer pattern is considered one of the best reversal indicators for finding penny stocks to buy or identifying when it may be time to sell. The hammer is a candle that, well, looks like a hammer. It has a short body with a long wick.
This is an indication that after a big move (up or down), major buying or selling power brought the stock back up above or below its opening price. While this pattern works, it has to be confirmed like any other indicator. The best type of confirmation is if you see a volume spike where the hammer occurred.
The double bottom and top patterns utilize the concept of support and resistance lines talked about earlier. A double bottom occurs when a stock bounces off a support line, comes up, then comes back down to test the support line. This is usually followed by another bounces right off of it again. The opposite happens with double top patterns; a stock gets rejected at a resistance line twice and then comes down.
This indicator can also be used in your scanner to locate
the largest movers quickly. A gap up occurs when a stock opens higher than the
previous trading days close. When a penny stock gaps up significantly, it’s
usually due to penny stock news and brings an influx of volume. Penny stocks
experiencing this tend to be a lot more volatile which means investors can get
large percentage gains.
Penny stocks are some of the riskiest equities you can invest in due to extreme volatility. However, this risk can bring an investor massive amounts of profits. The best part is that there are ways to mitigate the riskiness of penny stocks so investors can see improved odds.
I am going to hit this nail on the head one more time so everyone reading this has no chance of missing it. Penny stocks on the Pink Sheets or any company that is not properly disclosing its financials are EXTREMELY RISKY. They are way too risky with too many uncertainties that can work against you. Penny stocks on major exchanges or OTCQX/OTCQB listed stocks have far more information publicly available.
A common theme with penny stocks is known as “pumping and dumping.” This is one of the worst situations a penny stock trader can find themselves in. Pumping and dumping involves traders or larger investors buying a very cheap stock, hyping it up, then selling all of their shares to unsuspecting retail traders.
They talk up stocks that are worthless and leave other investors stuck in the terrible investment. The lesson traders learn from pumpers is do your own due diligence and research any investment you want to make.
Plans are essential when buying penny stocks. You will find that if you come in with a game plan before making a trade, you’ll likely be able to better manage risk. Your game plan should consist of a few things. It should include where you plan on entering and exiting a stock. Furthermore, include the amount of money you are willing to lose. Especially with high-risk investments, many will have a rule of thumb to only risk what they can afford to lose.
Based on your personal risk tolerance, it could be better to be a penny stock trader rather than an investor. The volatility from penny stocks makes long-term investing riskier than intra-day or quick swing trades.
One thing penny stock traders sometimes forget to do is take profits when they’re up. If you are up 20%-30% on a trade you’ve officially outperformed the market; congratulations. Now what? Greed can set in and a winning trade can turn into a losing one very quickly. Just know that no one ever went broke by taking profit.
You can always put more money in if you feel the stock is still strong. Taking the profits you have earned boosts your mindset and your portfolio value. Just imagine gaining 20% and you decide to wait it out and the next second you are down 20%. This is something that might happen if you leave those profits on the table. So, as important as it is to manage risk, it’s important to manage reward as well.
Some Closing Thoughts About How To Make Money With Penny Stocks
This guide, while informative, is only the tip of the iceberg when looking for how to make money with penny stocks. Everyone should do more research on trading penny stocks and even more research on penny stock companies. Remember, you are investing YOUR money. You should do everything in your power to make money instead of losing it.
When trading any kind of security, experiences only make you a stronger trader. This is important to remember because getting used to trading penny stocks can take a couple of months to understand. A good way to learn is also through paper trading where you can develop your trading strategies.
Plenty of platforms provide paper trading options like TD Ameritrade. Essentially, you are using imaginary money to hone your strategy. While you don’t make real money with winning trades, you also don’t lose real money with flops either.
It is very possible to make money with penny stocks. However, do not risk your financial security trying to get into it. Take your time and learn and you will greatly appreciate it in the end.
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