If you’re like most traders in the stock market today, penny stocks are something to get familiar with. Now, keep in mind, I say “traders” and not “investors” for a reason. In many cases, these cheap stocks fluctuate rapidly in price more than your average equity. This is one of the main attractions to traders, especially. Under the right circumstances, they can use less capital in exchange for higher percentage returns. If you’re new to trading, new to penny stocks, or a mix of both, you should start by learning the basics.
Penny Stocks Definition
Generally speaking, the term “penny stock” refers to a small company’s stock with a share price of $5 or less. Popular opinion associates these low-priced equities with the Over-The-Counter Exchange or OTC. But there are plenty of stocks under $5 that trade on major exchanges like the New York Stock Exchange and Nasdaq Exchange.
You might have gotten familiar with trading penny stocks thanks to attention on companies like AMC Entertainment (NYSE: AMC), Nokia (NYSE: NOK), Novavax (NASDAQ: NVAX), Cassava Sciences (NASDAQ: SAVA), and countless other companies in 2021. These are just a few examples of stocks that went from sub-$5 to over $300 in some instances.
With a new year in-toe, 2022 has become known as the year of the active trader. Almost daily, we see cheap stocks exploding 20%, 50%, 100%, or even higher. While witnessing monumental moves like this is exciting, participating and profiting from them is even more enticing.
How To Trade Penny Stocks
It all starts with learning how to trade stocks. Unlike larger market capitalization companies, including the likes of Apple (NASDAQ: AAPL), or Tesla (NASDAQ: TSLA), penny stock trading is a bit more unique. You generally look at shorter time horizons for entering and exiting a trade. But there’s also potential for a much longer-term investment when all the stars align.
Remember, the goal is to make money with penny stocks, so learning a different style of trading can be helpful when determining the type of trade (or investment) you’re looking to make. Today we look at a few different techniques that active traders use to make money with penny stocks every day.
This might be the most frequently used style of trading: day trading. As the name suggests, day trading involves a buy and sell of securities within the same trading day. The position is closed before the final bell, and nothing gets held overnight.
Thanks to the rise of retail traders over the last few years, millions of new accounts were opened, adding even more day trading liquidity to the market. When you’re actively day trading, liquidity is your friend. This refers to how many or how few shares of stock are traded in a particular issuer. The higher the liquidity, the easier it is to enter and exit a trade. This is critical if you’re using a day trading strategy to make money in the stock market.
Trading 101 Pro Tip: If you’re learning how to day trade, some platforms offer a way to do simulated trading and use fake money to practice your strategy. While you won’t make the big bucks on a winner, you won’t lose money if you make a mistake.
I’d also like to mention another strategy that can fall into the “day trading” category: scalping. Similar to day trading, scalping involves buying and selling within the same session. However, unlike day trading, a scalper is looking to take advantage of small moves in share prices within a very short period. Traders who scalp aren’t looking for big moves in share price but rather small yet frequent moves. Liquidity is even more critical for a scalper as it is imperative in entering and exiting trades quickly.
Penny stocks can fluctuate in price rapidly, and most retail traders will take up day trading as a result. However, not all penny stocks break out and break down during a single session. Many go on to climb for days and even months.
A strategy called swing trading is used to take advantage of these moves. Day traders won’t hold “overnight,” but swing traders actively search for trade set-ups that have the potential for overnight holds. This style has become popular with those who’ve got a full-time job or can’t actively focus on the market all day. If you’re looking to swing trade penny stocks, it’s important to remember that things can change quickly.
One example is overnight financing deals. If share prices rise substantially, companies will take advantage of the premium and hold a stock offering with their banker. They’ll issue shares in exchange for the funds and generally, offer them at a discount to the current market price. If you’re a swing trader, this can blindside you if you’re aren’t adequately hedged. The tricky part is that offerings aren’t usually announced in advance. So keep this in mind if you want to swing trade penny stocks.
Hold A Core, Trade A Core
Some may consider this a type of “long-term” swing trading style. Others might place it more akin to investing. The “Hold A Core, Trade A Core” approach is generally used by traders who want to make a longer-term investment into a company. But, since penny stocks are still volatile, they may want to take advantage of short-term trends too. Let’s best define this with an example:
A trader finds PubCo A has done some impressive things, raised money, and thinks it could be a good investment at $2. They take a starting position in the company, and the share price rises to $2.50. That trader then increases to a full position, and the average cost per share is $2.30; this is their core in this example. If the price jumps to $3.50, that trader sells part of the position to take advantage of the short-term move, put the cash in reserve and wait for another pull-back to buy back. The idea is to keep the “core” at a lower cost average than the current market price. This allows the trader to stay in the trade longer while also taking advantage of short-term opportunities.
A “Hold A Core, Trade A Core” strategy would have played out perfect for anyone looking to capitalize on the 8,000%+ move in Novavax stock between the start of 2020 and early 2021. It’s not the only example, but it is a very popular one referenced when it comes to the top penny stocks in recent history. Also, this strategy has also been referred to as “tier trading” or cost averaging.
Are Penny Stocks Worth It?
With the right strategy, trading game plan, and market know-how, penny stocks can be worth it. If you can handle risk, you’re already halfway there. Not every trade needs to be a home run and “tomorrow” is always a new day to make money in the stock market. The point is, no matter what style you use, turning a profit is the goal.
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