Investing in penny stocks can be quite risky trade despite the potentials for huge profits. This article brings to mind the interesting and excellent movie – The Wolf of Wall Street.
Jordan Belfort took an entry-level job at a Wall Street Brokerage firm but events forced him out and he had to pick another job with a smaller firm selling penny stocks to the public at huge margins.
He eventually started his firm, Stratton Oakmont with his lieutenants and other brokers, we all know how the story progressed. If you don’t you should make out some time to watch it; it’s one of the best finance movies ever made.
Penny stocks are defined as micro-cap stocks – a stock with a market capitalization between $50 and $300 million, if the company is valued at less than $50 million, it is considered to be a nano-cap stock.
They often trade for less than CA$5 per share however, most penny stock will likely go onto zero eventually. Penny stocks are listed and traded on pink sheets and Over-the-Counter (OTC).
Reasons for Penny Stock Risk
Penny stocks are highly risky investments for these reasons:
- Lack of public information: Companies listed on the pink sheets are not required to file with the Securities & Exchange Commission (SEC) like larger stocks traded on an exchange. This makes it difficult to find tangible information on penny stocks.
- Noncompliance with minimum standards: Sometimes, they often don’t meet the minimum standards to be listed. These standards include annual listing fees and timely filing of financials.
- Undocumented or poorly documented history: Whether the company is newly formed or approaching bankruptcy, many penny stocks generally have poor track records or none at all.
- Low liquidity: Investors cannot easily buy or sell shares without finding a willing buyer or seller. Low liquidity also leads to price manipulation and the threat of scams.
Penny Stock Tiers
Penny stocks can be classified into several categories which we can call tiers.
Some small companies’ stocks are trading under CA$1.00, such companies often struggle to find their place in the market and as a result, such stocks were very speculative investments for traders or investors.
Some other stocks are priced between CA$1-10.00 and in many cases, they still represent some of the most speculative and risky investments.
In this article, we shall discuss four (4) tiers of Penny Stocks:
- Tier 1 Penny Stocks
These are listed on a major exchange like the NYSE or NASDAQ and are usually priced below $5.00 per share but can be a little higher priced than that.
Tier 1 penny stocks are still speculative but less open to manipulation because they are required by the exchanges to provide financial information and are held to a higher standard than OTC penny stocks.
- Tier 2 Penny Stocks
However, companies that would list such stocks will typically get a letter, often made public, that they need to meet the listing requirements to have their stock above $1.00 within a certain amount of time.
If they achieve it, the stock remains listed, if they can’t it will be de-listed and move to the OTC market exchange.
Moreover, it’s important to note that stocks that trade above $1.00 will never have a spread of less than 1 penny. That means the stock will trade 1.01 x 1.02, or 1.05 by 1.06, but never 1.015 x 1.017.
- Tier 3 Penny Stocks
These are Sub-Penny Stocks that are below 1 penny per share. So that starts at .0099 and below.
These shares will not be listed on NYSE or NASDAQ but can only be traded OTC, so for that reason, we suggest you avoid trading such stocks.
These aren’t particularly noteworthy beyond the fact that the companies aren’t strong enough to even have their stock priced at 1 penny per share.
- Tier 4 Penny Stocks:
These are Trip Zero Stocks which are priced with 3 zeros. These are stocks priced between .0001 and .0009 per share.
These stocks after often used as vehicles for manipulation. Each increment the stock moves up is a 100% move versus the entry price of .0001.
Trading Penny Stocks in Canada
One of the most famous penny stocks in Canada was Bre-X Minerals, the Calgary-based exploration company whose stock soared from 30 cents per share to more than CA$250 before being exposed as a fraud in 1997.
To buy and trade penny stocks in Canada, we request potential investors to see the following steps to trading:
- Step 1: Research
Ensure the penny stock companies you’re interested in are legitimate. Do your due diligence and look into companies before investing in their cheap shares.
Potential investors can go to the Securities and Exchange Commission (SEC) website to see if the stock has been recently delisted from a major exchange. They can also get copies of the company’s most recent SEC filing to get an idea of the company’s overall financial health.
- Step 2: Engage a broker
Research online will provide quick results on which brokers are the best for penny stock aficionados.
A bunch of online brokers charges extra for penny stock trades, which makes penny stocks more expensive. Typical examples are Questtrade, TD Ameritrade, Wealthsimple Trade, and others.
- Step 3: Determine which stock to trade
There are various platforms online that list penny stocks, potential investors can also use tools that exist on the OTC Markets website to determine the penny stocks to trade.
Also, know that the OTC Markets Group organizes securities into tiered marketplaces that can help investors determine which stocks to trade.
Beginners can also explore the Finviz stock screener which is available with limited resources. It also provides access to all of the Finviz platform including premarket data.
- Step 4: Join a day trading chatroom
Beginners can learn a lot about penny stock trading in a day trading chatroom. Beginners can also get a mentor who knows a lot about trading the stock market.
Notable Parameters in Penny Stocks Trade
The following parameters can serve as indicators for penny stock investors to decide stocks to trade:
- Breaking News
Investors can look out for stocks that are gapping up because of some kind of news catalysts like FDA approval or earnings but investors should avoid stocks that are being bought out because they usually don’t trade away from their purchase price.
Floats under 100 million shares but preferably under 50 million are even better for investors. This is because when a stock has a small number of shares to trade and there is a lot of buying interest then it could push shares up very quickly which is exactly what we are looking for.
- High Relative Volume
Usually, stocks with positive news will be gapping up in the premarket on really good volume. This is an indicator that this stock will have plenty of liquidity for investors to trade.
Tips for Beginners of Penny Stock Trade
- Avoid OTC/Pink Sheet-Listed Penny Stocks
Companies trading on the OTC market have fewer regulations placed upon them as compared with stocks listed on the NASDAQ and NYSE. As a result, stocks on the OTC market are highly susceptible to manipulation and fraud.
- Don’t Fall for the Promotional Pumps
Many OTC Penny Stocks become promoted at one point or another. These promotions often come with messages like “this stock will be the next Tesla”.
The reality is, the next Tesla is not likely to come from the penny stock world. It’s more likely the next big tech company will start as a large company that IPO‘s well above the penny stock price range, and then continues the drive higher.
When you are buying penny stocks to hold in hopes that it will be the next Tesla, you become an investor of one of the most speculative financial instruments on the market.
- Only Trade Penny Stocks with Volume
It’s really important to avoid illiquid penny stocks. Most penny stocks trade only a few thousand shares a day.
However, when a penny stock has breaking news, they will often trade at 40-50x relative volume achieving 5 to 10 million shares of volume on a big day.
- The Hit and Run Approach
Once a penny stock has met the expectations for being worthy of trading (having news, volume, and being NYSE/NASDAQ listed), beginners are advised to invest and once they have a profit, sell a minimum of half of their position on that stock to break-even, at least. By quickly taking profit and adjust stops, beginners can gather many small wins.
- Trade on Daily Targets
Beginners mustn’t look to hit home runs, to make huge returns in a single trade. Their focus should be to trade penny stocks almost every day and have a daily target of $500-1k/day.
Trading penny stocks isn’t for everyone. It requires a certain amount of risk tolerance along with the ability to react quickly in uncertain situations.
Every beginner should trade cautiously with money management techniques; start with a trading simulator where you can practice trading without risking real money. Always consult a financial advisor before making any investments.