How to invest in penny stocks & why you might want to

Penny stocks are an affordable way to invest but they also pose a lot of risk, especially for inexperienced investors.

Derek Silva

Derek Silva

Published June 18, 2019

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KEY TAKEAWAYS

  • Penny stocks have a value of less than $5, according to the SEC

  • Many penny stock companies aren’t subject to the same laws and regulations as other stocks

  • Trades occur in over-the-counter (OTC) markets, not major exchanges

  • Consider ETFs instead if you’re trying to build wealth

A stock is a security (a tradeable asset) that represents a share of ownership in a company. Since stocks give you a share of ownership in a company, they’re also called shares. When a company does well, stock prices generally increase and thus you profit because your shares are worth more.

Issuing stock is a common way for companies to raise money that they can then invest back into their company. To issue stock, companies need to “go public.” That just means they’re issuing shares that the general public can trade. Companies go public via an initial public offering (IPO).

Large, successful companies often make the news for the prices of their shares, but smaller companies also sell shares. That’s where penny stocks come in.

In this article:

What are penny stocks?

According to the U.S. Securities and Exchange Commission (SEC), which regulates the securities industry, a penny stock is one that trades at less than $5 per share.

Since large companies, like Apple or Google, have share prices well above $5, penny stocks are generally from small companies that issue many shares. However, it’s possible that a successful company can find itself as a penny stock if they struggle financially. For example, the company that owns MoviePass was once listed on the NASDAQ stock market and had a share price of more than $30. As of June 2019, the share price is less than one penny.

Most commonly, the companies with penny stocks are considered small-cap companies. Small-cap companies have a market capitalization between $300 million and $2 billion.

Market capitalization (also called market cap) is the value at which the company is traded on the stock market. You can calculate it by dividing the number of public shares by the value of each share. For example, a company with 20 million shares that are each worth $50 has a market capitalization of $1 billion.

You will also find penny stocks for even smaller companies. Micro-cap stocks are from companies with a market capitalization between $50 million and $300 million. Companies at the lower end of this group may have a harder time getting listed on some of the major stock exchanges.

Companies with a market capitalization of less than $50 million are nano-cap stocks. You won’t see many of these companies on a large stock exchange unless they were listed and then their value prices dropped.

The risks of penny stocks

Penny stocks are enticing because they are so cheap per share. However, penny stocks are not the best investing option for most people. They come with quite a bit of risk. That’s not to say you shouldn’t trade them, but you should understand the risks before you invest any money.

Fraud

Before all else, beware of fraud with penny stocks. Companies and scammers regularly manipulate the market in order to make a profit.

The most common scam is the pump and dump, which gained wider recognition from Jordan Belfort (The Wolf of Wall Street). Scammers buy a lot of an unknown or very cheap stock and then get people to create interest in it. This happens by paying for online promoters, websites, or newsletters to feature their stock. Inexperienced (and often new) traders see the interest and buy the stock. The surge of purchases pumps up the price and the people behind the scam will sell all of their stock at a big profit. The stock price will crash back down, leaving traders out of their money.

The opposite type of scam, which is also common, is the short and distort. Scammers sell a stock and then spread negative rumours about the company so that the stock price decreases. Then they buy more of the company stock at the lower price. This is common with people who are borrowing stocks. Stock lending and borrowing works similarly to a loan. If you ever participate in stock borrowing, this is an important type of fraud to remember.

Low liquidity

The other major concern with penny stocks is that they are not always easy to sell. Let’s say you own 5,000 shares and you want to sell them all. If people are only buying about 1,000 shares of that stock each day, it will take you at least five days to sell yours. If there are other sellers in the market, you could be waiting weeks. With traditional stocks, there is enough demand to buy your shares and you can execute many trades in a day or two.

While low liquidity isn’t a problem in and of itself, it’s important that you do not invest money that you think you will need quickly. You definitely shouldn’t be using important savings or an emergency fund to invest.

An alternative to penny stocks: ETFs

If you want to start investing but don’t have a lot to invest, penny stocks likely aren’t the best choice for you because of their risks. A better option is probably exchange-traded funds (ETFs).

An ETF works like a bundle of stocks that includes small amounts of multiple stocks. ETFs trade on exchanges and you buy shares just like other stocks. Unlike most stocks and mutual funds, the minimum investment for an ETF is often just a penny.

Multiple brokers offer commission-free trades of ETFs, allowing you to buy and sell shares without paying a fee. You can also invest through a robo-advisor. Robo-advisors handle the hard work of investing for you by creating and managing a portfolio based on your goals.

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Where you buy penny stocks

There are two main ways to trade stocks. Most companies trade on stock exchanges, like the New York Stock Exchange (NYSE). However, exchanges have listing requirements that a company must meet in order to list and sell shares through the exchange. The requirements preclude most companies that qualify as penny stocks. For example, the NYSE requires a minimum share price of $4 for a company to begin public trading.

In order to trade penny stocks, you need to use what’s called an over-the-counter (OTC) market.

With a stock exchange, supply and demand determine the share price of a stock. With OTC markets, the person who holds the share decides the price they would accept per share. These markets are decentralized, meaning there’s no single site where everyone goes in order to make trades. This also means there is no standard pricing. You also may not know the price that a seller originally paid for their shares.

The major over-the-counter market

The OTC Markets Group operates the largest online trading system for penny stocks. You can think of it like a NYSE or NASDAQ for penny stocks. The OTC Markets Group handles trades through a platform it calls the OTC Link® ATS, which is registered with the SEC as a broker-dealer.

Shares traded through the OTC Markets Group are in one of three market tiers, depending on how much financial information the company provides and the quality of that financial information. From highest to lowest standards, the tiers are

  • OTCQX Best Market (penny stocks do not qualify)
  • OTCQB Venture Market
  • Pink Open Markets (formerly OTC Pink)

The highest financial standard is for OTCQX companies.These companies have to demonstrate full compliance with U.S. securities laws and be current with all financial disclosures. International stocks can list, but penny stock companies cannot qualify for this tier.

The OTCQB tier is for early-stage and developing companies. Financial standards are less strict than for the OTCQX but regular reporting is still necessary. Both U.S. and international companies can list their shares.

Most companies that don’t qualify for the two tier above can qualify for Pink Open Markets. There are no financial standards or disclosure requirements for this tier. Companies in bankruptcy can still list here. You should approach any companies in the Pink tier with caution.

How to start trading penny stocks

In order to actually buy or sell penny stocks, you need to create an account with a broker. Then, after you fund your account, you can choose a stock to buy.

Choose a broker

A brokerage firm is your link to the stock market. This is true whether you are trading penny stocks or through a major exchange.

If you plan to trade penny stocks in addition to other stocks, make sure to find a broker that allows you to do so. The best case scenario is that your broker allows you to trade all stocks through the same online platform. If the broker requires a different platform for penny stocks or if they require you to make trades over the phone, look for another broker.

As you research brokers, it’s very important to understand their fees and minimums. Do they require a minimum account balance to start investing? How much do they charge per trade? Penny stock traders should also look out for trade surcharges.

When the value of a stock is below a certain threshold, many brokers will charge an additional fee per share. This surcharge varies by broker and so does the threshold for collecting it. Some brokers charge it for stocks valued under $1, $3, or $5. Your best option is probably to avoid brokers with a surcharge. Instead, find a broker that charges a flat commission no matter what the value of your shares are.

You should also know how many shares you’re allowed to trade per day. Some brokers restrict how many shares of penny stock you can trade in a single day. Brokers may also charge a fee if you trade more than a certain number of shares. Since penny stock trades usually involve a large number of shares, volume restrictions can make trades costly.

Below is a list of some common brokers with penny stocks:

  • Ally Invest
  • Charles Schwab
  • eOption
  • E*TRADE
  • Fidelity
  • Interactive Brokers
  • TD Ameritrade
  • TradeStation
  • Zacks Trade

Open and fund your account

Once you choose a broker, you can create an account. You can expect to give your contact information, Social Security number, identification information from a driver’s license or passport, employment status, annual income or net worth, and information on your investment objectives.

The broker may also ask you to add contact information for a trusted person. This is someone the broker will reach out to in certain situations, like when you are a possible victim of financial exploitation. The person isn’t a beneficiary and cannot use your account. Adding a trusted person is optional.

When you create an account, you can fund it with a bank-to-bank transfer. Just provide the account number and routing number for one of your bank accounts.

Choose a stock to buy

The first step of trading is picking stocks that you want to buy. As with any other stock investments, the key is research, research, research. Read all of the financial documents from a company and if they don’t have documents, proceed with extreme caution. Look into the owners of the company. They may have a history of running other companies.

As you research, make sure you aren’t relying strictly on the company’s own forecasts. Many penny stock companies are trying to make themselves sound as good as possible so they can raise the stock price enough to sell the company (or just avoid going out of business).

Many traders choose to focus on a certain sector or industry. That could mean agriculture, clothing, or anything else you have knowledge in. A stock screener is a useful tool as you search. You can find one either online or as a standalone app. (The OTC Markets Group offers a free stock screener on their website.) Stock screeners allow you to filter by type of security, industry, cost, volume of the stock, and previous performance.

List of penny stocks

It’s impossible to create a definitive list of the best penny stocks because they change frequently in both value and volume. When you’re ready to trade, make sure you check for the most recent information.

Just to give you an idea of the kinds of stocks you might see while you research stocks, here’s a list of the 30 highest-volume stocks, with a price below $1, that are listed through the OTC Markets Group. This list is current as of June 14, 2019.

SymbolStock namePriceShare volumeCountry
IFLMIndependent Film Dev Corp$0.0005482,685,853United States
LAHOLans Holdings Inc$0.0007314,190,488United States
PHILPhi Group Inc$0.0001211,765,877United States
KYNCKyn Capital Group Inc$0.0006202,417,469United States
ETEKEco-Tek Group Inc$0.0001123,774,670Canada
BANTBantek Inc$0.0002119,613,846United States
GXXMGex Mgmt Inc$0.000291,233,791United States
DGTWDigitaltown Inc$0.000687,035,278United States
VPORVapor Group Inc$0.000986,084,254United States
PWDYPowerdyne International$0.000760,318,156United States
CMGOCmg Holdings Group Inc$0.009556,719,436United States
MINEMinerco Inc$0.000251,529,690United States
OCLNOriginclear Inc$0.000447,171,514United States
LIBELiberated Energy Inc$0.000143,970,445United States
ARYCArrayit Corp$0.019442,751,887United States
JAMNJammin Java Corp$0.000140,950,432United States
GRDOGuard Dog Inc A$0.001740,702,835United States
UNVCUnivec Inc$0.012540,081,454United States
TTCMTautachrome Inc$0.004538,265,412United States
RBIIRising Biosciences Inc$0.003235,960,084United States
ONCIOn4 Communs Inc$0.000934,445,798United States
BMIXBrazil Minerals Inc$0.000833,962,510Brazil
CBBTCerebain Biotech Corp$0.001233,758,065United States
GGIIGreen Globe Intl Inc New$0.000633,404,353United States
FERNFernhill Corp$0.000532,607,065United States
VIBIVilacto Bio Inc.$0.000332,149,820Denmark
COHOCrednology Holding Corp$0.000429,813,423United States
ETFM2050 Motors Inc$0.000629,023,000United States
AHIXAluf Holdings Inc$0.000527,000,014United States
ENDVEndonovo Therapeutics Inc$0.012926,248,738United States

Note that the companies in this list of penny stocks are not all in the U.S. Additionally, all except one of the companies listed above fall into the Pink Open Markets tier mentioned earlier. They provide limited, if any, financial information.

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