Stock Market

Penny Stock—What is it, how to trade it, and should we buy it or not?

When most people first think about trading stocks it quickly occurs to them that, to make a profit, they will need a good amount of money upfront. The old adage that it takes money to make money certainly holds true in the stock market. But not all stocks require an upfront investment of thousands of dollars just to buy a few shares. Stocks that trade for under $5 per share in the United States are called penny stocks.
These stocks are usually connected with small companies that are usually in the early stages of their IPO or initial public offering. Other times these companies may have experienced some type of financial or managerial difficulties that caused their share price to dip into the penny stock category.

Be Careful of Penny Stock Scams

In some cases you can buy multiple penny stocks for a single US penny. These stocks offer the most potential rewards, but are often the target of scams where an individual or group will stir up interest in a particular penny stock they themselves are heavily invested in. Once they’ve pushed the price up they will pull their shares out, pocket a nice profit, and let the stock price drop. This type of scam is called a “pump and dump” scam and, almost always, results in everyone besides the scammers walking away empty handed.
Because penny stocks are ripe targets for scammers, any investor looking to trade in penny stocks should be wary of potential scams. It is always advised to ignore penny stocks that are being advertised as the next big thing, or that are brought to your intention through email, text, or phone call. While not all penny stocks that are advertised in this way are scams, the potential for them to be scams is very high.

How to buy penny stocks

The best way to trade penny stocks is to use a reputable online broker. Most of the major online brokers allow you to trade in penny stocks, but there are a couple of things to check before choosing an online broker for trading penny stocks.

How does the broker define a penny stock?

Not all online brokers define penny stocks the same way. While the Securities and Exchange Commission defines a penny stock as any stock trading under $5 per share. Some online brokers cut off penny stocks at those trading for under $3 or even under $1 per share.

What are their fees?

All online brokers charge fees, and with penny stocks it’s possible the fees could cost you more than the actual stocks cost. Note that online brokers can charge both a standard commission and additional fees per share of stock traded.

What are their restrictions and minimums?

Some online brokers require you to maintain a minimum balance in your account, while others do not. Some brokers may also restrict the volume of penny stocks you can trade, or restrict the use of their online system for penny stocks. A few online brokers also restrict or disallow the trading of sub-cent stocks.

Should you buy and sell penny stocks?

If a person is careful to avoid the many scams associated with penny stocks, and finds an online broker that fits their trading style, then penny stocks can be a great introduction to stock trading. They can also supply a good ROI or return on investment. The downside, of course, is that even when a scam is not involved the very nature of penny stocks makes them very volatile and thus very risky.
If you’re looking for a way to get rich quickly, penny stocks aren’t going to do it for you. But if you are looking for an exciting introduction to stock trading, and can handle the risks involved, penny stocks might be right for you.