How To Trade Penny Stocks: A Beginner’s Guide |
Penny stocks can be the “stuff of legend” when they perform well. If you look at the history of cheap stocks, you’ll likely find countless names that produced massive gains for investors. Some companies have even become market leaders competing with the likes of Pfizer (NYSE: PFE) and Moderna (NASDAQ: MRNA). This was the case with shares of a little-known biotech working on a treatment for influenza at the end of 2019.
The 2020 pandemic shifted its fate, and Novavax (NASDAQ: NVAX) grew to become one of the top penny stocks in the last five years. If you were a reader back then, you would have seen NVAX stock trading under $4 and ultimately ran to highs of $331.68 within a year’s time. It has been 8,100%+ moves like that, which have remained an attractive proposition for traders looking to leverage their money.
What Are Penny Stocks
The definition of penny stocks includes stocks to buy under $5. Popular opinion likens all penny stocks to Over-The-Counter start-ups. However, there are plenty of NYSE and NASDAQ penny stocks to buy. The term “penny stocks” shouldn’t be confused with “small-cap stocks” either. The “cap” in this term refers to the market capitalization of the underlying companies. In the article Are Penny Stocks Good For Beginners? [Answered], we shed some light on this topic.
Generally speaking, market caps or “market capitalizations” are divided into different segments. None of these segments have anything to do with price being the defining factor:
- Mega-cap stocks: These are companies with market capitalizations above $200 billion. Apple, Amazon (NASDAQ: AMZN), Tesla (NASDAQ: TSLA), etc., fall into this category.
- Large-cap stocks: Companies with market capitalizations of $10 billion – $200 billion.
- Mid-cap stocks: Companies with market capitalizations of $2 billion – $10 billion.
- Small-cap stocks: Companies with market capitalizations of $300 million to $2 billion.
- Micro-cap stocks: Companies with market capitalizations of $50 million to $300 million.
- Nano-cap stocks: Companies with market capitalizations below $50 million.
Case in point, Banco Santander (NYSE: SAN) is the “largest” penny stock by market cap at more than $40 billion. It’s a stock that can be bought for less than $3 per share. Meanwhile, you’ve got Village Bank and Trust Financial Corp. (NASDAQ: VBFC), which trades above $50 per share but has a market cap below $80 million. Those are two very different stocks with two very different market capitalizations.
How To Trade Penny Stocks
How do you trade penny stocks and make money? The strategies for trading stocks under $5 vary depending on the type of investor you are. It would serve you well in learning the most commonly used techniques and seeing if they can be applied to your game plan. No matter your experience level, this guide can help you understand the basic trading styles.
Trading penny stocks can be very lucrative, but it takes some know-how to get there. Luckily we have 4 of the most commonly used strategies for you to learn. Trying out new things is always risky – why take that chance? If you are learning how to trade penny stocks or haven’t traded in the past, utilizing a trading simulator is an excellent place to start. Simulators allow you to risk fake or “paper” money instead of your own. While you won’t make big bucks from winning trades, a significant loss won’t negatively impact your real back account either and will allow you to learn from your mistakes.
The first place to begin is learning the different ways to play the market and how numerous trading styles can be used to profit from other moves.
How To Trade Penny Stocks #1: Scalping
Scalping is a typical trading style used by active traders. The basic idea of scalping, as the name suggests, is to execute many trades throughout each day and take profits based on rapid price changes. Think of quick small bites versus trying to invest in one big dish at once. To be successful, though, you need more than just good insight into prices; there’s also timing involved. Making investments quickly before the opportunity is gone or getting out when things get too high risk is critical. Scalping isn’t for everyone and should be conducted by experienced traders.
How To Trade Penny Stocks #2: DayTrading
Whether this is your first foray into the stock market or you’re a pro, you’ve likely heard of day trading penny stocks. Day trading is all about finishing out a trade before that day’s closing bell. Holding a position overnight is not usually part of the game plan.
What’s interesting about day trading penny stocks is that these traders don’t aim to capitalize on any overnight activity. While it is a slower trading style than scalping, it isn’t more or less risky. Day traders usually pay attention to more than just price action. Media headlines and speculation surrounding the stocks they’re watching are also used as tools. Day trading is a very active trading style within a finite amount of time.
One of the main downsides that new traders face is when they allow emotion to play a role. The idea of “what if it goes higher” or “what if this is the bottom” can cause more pain than anything. That’s why, no matter the type of trade you’re making, having a plan and determining things like profit targets and stop losses is key to becoming consistently profitable.
How To Trade Penny Stocks #3: Swing Trading
Swing trading penny stocks refers to a style of trading used by traders trying to make gains over a more extended period. This is usually longer than that of a day trader or a scalper. Naturally, there are two types of swing trading: short-term and long-term.
Short-term swing trading focuses on anywhere between one to two days. Like day trading, short-term swing traders use very little fundamental analysis. Compared to day traders, short-term swing traders must be wary of overnight price action. Gap ups or gap downs can make their trades far riskier.
For instance, if you’re a swing trader and found a penny stock that has consistently risen over the last week, you might take a position. Outside of your control or foresight, late in the evening, the company announces a financing that was done at a steep discount to the market. There is a gap down the next day, essentially wiping out any gains and may even eat into your principle, presenting a more significant loss. This is a risk that swing traders take on, which day traders or scalpers don’t usually encounter.
Long-term swing trading focuses on price movements over several weeks or months. Many refer to this style of trading as “the long game.” Like short-term, long-term swing trading is susceptible to gap ups and gap downs. But the difference is that long-term swing traders will typically ride out these movements in hopes of more sustainable growth over time.
How To Trade Penny Stocks #4: Investing
Investing in penny stocks is an entirely different ball game than trading. Long-term investors will prepare to hold positions for several months to several years. Those investing in penny stocks tend to rely more heavily on company fundamentals or broad market events compared to price action or speculation.
While penny stocks aren’t typical investment choices, that doesn’t mean they aren’t worth it. If you want to invest in penny stocks, understand that pricing risk can play a significant role. For any investment type, it’s best to consult a professional before making any investment decisions.
Final Thoughts On Penny Stocks
Now that you’ve got some of the basics of how to trade penny stocks, it’s time to learn what to look for next. What I mean by this is your journey is just beginning. Identifying your trader identity is critical in finding penny stocks to buy that fit your approach to making money in the stock market. If you are new, check out some of our articles on penny stock basics: