How to Trade Penny Stocks

Before you can get started on learning how to trade penny stocks, it is of utmost importance that you understand first what penny stocks are to begin with. Knowing what penny stocks are will give you the right kind of knowledge to help your maneuver your way around trading, letting you become a successful trader in the long run.

Defining Penny Stocks

There aren’t any real definitions set for penny stocks but they are generally considered to be stocks that trade for such low prices and market capitalization, with trading typically done outside of major market exchanges. Penny stocks are usually considered to be high-risk and highly speculative because they don’t have liquidity, there’s small capitalization involved, there are large bid-ask spreads, and you have to contend with limited disclosure and following. Some are considered to be penny stocks if they are traded for less than $5, or literally pennies, which some are considered as such when there are trades off major market exchanges. There might even be some confusion as there are large companies that trade stocks for less than $5 as well, and there are small companies that do trade stocks for more than $5. In learning how to trade penny stocks, you will see that the typical penny stock is actually a very small organization with highly speculative and illiquid shares. The organization in question will also be generally subjected to less stringent regulatory and filing standards, along with limited listing requirements.

Some terms to remember:

In the course of learning how to trade penny stocks, here are some of the terms you will encounter:

  • OTC market – the over-the-counter market is where penny stocks are traded. It features the National Quotation Bureau, more commonly known as Pink Sheets, where all pricing information are printed out on long sheets of pink paper. These pink sheets are nearly impossible for small investors to access and so will require the services of a broker to get accurate price information.
  • Principal/Agency – the principal is simply the main man in a transaction, while the agency or agent is your broker. Agencies are in charge of arranging transactions between you and a third party directly, where you are the principal. In certain cases, agencies may also act as the principal when the need arises.
  • Bid/Ask – penny stocks are not assigned single prices at which they can be bought or sold. Rather, different prices are in place. The bid price is basically how much you could be selling your shares, while the ask price is how much you have to pay to get a share. There are two kinds of bid and ask prices: inside and outside. Pay attention to the outside bids and asks, or the lower bids and the higher asks, as these are the bid/ask prices presented to the public.
  • Spread – the spread is simply the difference between the bid price and the ask price. To a lot of investors, it represents built-in losses when an investment is made. This is important to keep in mind when learning how to trade penny stocks as this will help you evaluate price information.