Penny stock trading. The main points to bear in mind
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Skilling Writers Team
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- Trading
- Stocks
You may see the purchase of penny stocks mentioned as a possible investment strategy. This is an interesting type of share to buy and sell, but what are the advantages and risks of doing so? We’ll be taking a look at everything you need to know about this kind of stock trading.
What is a penny stock?
The concept of penny stock is almost as old as stock markets themselves, as there have always been companies happy to sell large volumes of cheap shares. Just as there have always been investors willing to buy them. This market was first regulated in 1934, when the US authorities brought in the Securities Exchange Act to define penny stocks.
This is a type of low-value share that is usually for a relatively small company. The U.S. Securities and Exchange Commission (SEC) currently uses this definition to refer to stock valued at under $5. In the UK, a £1 upper limit is used.
Penny stock generally can’t be bought and sold on national stock exchanges. In many cases, a trade can only be made electronically using the OTC Bulletin Boards for over-the-counter transactions. These shares aren’t traded frequently, which can result in a lack of liquidity making it difficult to sell them.
5 signs of a penny stock worth knowing about
There is a huge level of diversity in the world of penny stock trading, and there are also risks involved in this way of trying to make money. These cheap shares can drop further in value or the company behind them could disappear. Penny stock scams have also cost investors money in the past, so you need to check the details of each company closely, rather than just look for a low stock price. Having said that, the following are some of the key signs that can guide you towards a penny stock to look at.
- Solid fundamentals are crucial.
- This could show a business that should be worth more. It could be genuinely under-valued for some reason, such as going through a poor spell due to external factors or they could be ripe for a buy-out by a bigger firm. Look for significant issues such as debt and cash flow, which are vital in any kind of stock trading.
- The industry is growing.
- Some of the most promising penny shares are in industries that are growing and could be set to hit new levels. Typically, this type of industry will have numerous small companies looking to break through. Not all of them will make it, but you may be able to identify one that has a better chance than others.
- A good management team is also essential.
- This is one of the key factors that show us whether a struggling business can be turned around or a promising enterprise can become a highly-valued stock.
- People are buying it.
- Making a profit from penny stocks is largely about buying at the right time. If people are starting to buy it but the price is still low, the timing could be right. If no one else seems interested in the share, you’ll want to ask yourself why this is.
- There’s a buzz about it.
- This last point is more difficult to define, but it’s mainly about the feeling that something big could be about to happen. You may see the name of the company pop up in various places or read good reports from reputable experts.
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Ideally, you’ll find penny stock that meets more than one of these conditions before you trade. The more of them you can tick off, the better.
What investors should know about investing in penny stock
There are some important points to consider when deciding whether investing in penny shares is the right move for you. We can start by looking at some of the advantages, before assessing the potential drawbacks.
Advantages of penny stock investing
- Potential for a significant stock price increase
- Only a small initial investment may be needed
- The chance to invest in an emerging industry
- Penny stocks have potential to perform well in a short period of time
Disadvantages of penny stocks
- A high level of risk is involved, as the value could drop further
- Stock trading in this type of share can be extremely volatile
- It can be difficult to find accurate information
- A lack of liquidity can make it difficult to sell this stock
The above list is a good starting point, but most real-life examples you find will give you a deeper insight.
The best tip here is to look for shares that meet as many of the positive points we’ve looked at, and as few of the potential risks, as you can. It’s impossible to remove all of the risks, but you’ll want to see as few of them as possible before you invest.
4 different trading styles in trading penny stock
Not everyone uses the same style when buying and selling these low-cost shares. Because of the volatility and risk involved, many people decide to try stock trading rather than choose them as long-term investment vehicles. Bearing this in mind, the following are some of the main trading styles to consider.
- Day trading
- Day trading is a short-term approach where you buy and sell them on the same day. This is a way to trade that you might want to do if you are confident that there is likely to be a significant but short-term upswing in the stock price.
- Position trading
- This is a longer-term approach that can be used if you’re convinced of the company’s growth prospects. Position trading is where you hold the shares for months or even years, looking to extract the maximum value before exiting the position.
- Swing trading
- This approach sees you hold a position for a few days or weeks. Swing trading is a popular way of trading penny stocks, because they are susceptible to large price swings in a short period of time.
- Scalping
- Scalping is generally the shortest-term method of starting to trade shares. In this case, you look to benefit from small price swings multiple times during a day.
Next steps
If you like the idea of penny stocks, you might like to research the following information to help you decide upon the next step to take. Our guide to CFD trading lets you understand how you can benefit from price swings on assets without actually owning them. This guide to trading styles gives you the information you need on each of the different methods of trading penny stock that you might like to try.
Not investment advice. Past performance does not guarantee or predict future performance.
