Investing For Beginners

Investing For Beginners is a series of articles, resources, and other information about basic investments, value investing, quantitative research and other ideas.

How to Buy Penny Stocks

Most penny stocks are not traded on a stock exchange and do not have high liquidity or financial information available to the average investor. However they are bought and sold online like other stocks.


What Are Penny Stocks?

Contrary to their name, penny stocks rarely cost a penny.  While many stock brokerages have their own definitions varying from less than $1 to less than $3, the Security Exchange Commission (SEC) actually considers any stock trading under $5 to be a penny stock.

And while there are sub-$5 stocks trading on exchanges such as the NYSE and NASDAQ, most investors do not think of these as penny stocks.  Penny stocks that are not listed on an exchange are traded Over-The-Counter (OTC). OTC stocks are available through market makers or small companies.

Are Penny Stocks a Risky Investment?

OTC stocks are generally considered to be much higher risk investments than non-OTC stocks as they are not subject to the compliance regulations imposed by the stock exchange. They have little in the way of reporting requirements and thus have less (or no) information available to the average investor. They also have less liquidity, meaning they trade infrequently, are harder to buy, and harder to sell once owned.

Be aware of the high possibility of fraud in penny stock investing. Many are the target of "pump-and-dump" schemes.  Pump-and-dump is a common tactic used by unscrupulous stock dealers who buy large amounts of a stagnant company's shares and then aggressively market that company as a good buy. The stock dealer then sells the shares at a higher price, though the company will likely collapse soon after. 

Stocks that trade at low prices tend to be very fragile and can easily go out of business, leaving you with worthless stocks. Penny stocks are therefore a "high risk, high reward" venture.

Here are some tips that could minimize risk and increase your chances of turning a profit.

How to Buy Penny Stocks

From an investor's perspective, penny stocks are bought and sold the same way as any other stock.  The first step is to open a brokerage account.  It is important to select a deep-discount broker that has flat trading fees for penny stocks.

Some brokers impose a percentage fee for low price stocks and the fees can be substantial.  Once an account is open then the investor can buy and sell penny stocks online.  A more detailed description of this process can be found here:  How To Buy OTC Stocks.

Final Words on 'How to Buy Penny Stocks'

Penny stocks have the potential of huge profits and tend to attract speculative traders.  But in the majority of cases, very low price such stocks tend to go bankrupt.  So if you are going to buy penny stocks then make sure you can afford to lose the money. 

And while there are sub-$5 stocks trading on exchanges such as the NYSE and NASDAQ, most investors do not think of these as penny stocks.  Penny stocks that are not listed on an exchange are traded Over-The-Counter (OTC). OTC stocks are available through market makers or small companies.

 

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